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Plunging oil prices impact Russell indexes at reconstitution

By: Mary Fjelstad, Senior Research Analyst

America’s recent energy boom isn’t a first for the country, and neither is the resulting drop in oil prices. In 1900, Texas produced approximately 0.84 million barrels of oil per year. In 1901, Captain Anthony Lucas drilled a prospecting well at Spindletop Ridge near Beaumont, Texas. HIs efforts yielded spectacular results and by 1902 Spindletop produced an estimated 17.5 million barrels of oil; giving birth to U.S. companies such as Texaco, Gulf Oil Co., Sun Oil Co., and Exxon Mobile (formerly Humble). As a result of the massive  increase  in supply, prices fell to a record low of $0.03 per barrel - cheaper than the cost of a cup of water in some oil boom towns.1

The dynamic of a significant rise in American energy production accompanied by sagging oil prices was back in focus this year as the annual reconstitution of Russell indexes took effect on June 26, 2015. When we look back over the 12-month period since the last reconstitution in June 2014, we see that the biggest increase in market share by a U.S. sector was in Health Care, followed by Financial Services and Consumer Discretionary (based on the Russell 1000® and 3000® Indexes). The U.S. Energy sector lost the most market share over the same trailing 12-month period.


 

Energy was the only sector in all three Russell Indexes to post double-digit negative 12-month returns over this period; in the Russell 2000® Index, Energy suffered a loss of 51% from July 1, 2014 to June 30, 2015.

Several factors contributed to this lackluster performance. We all are aware of the drop in gas prices, which have been underpinned by the plunge in the price of oil since June 2014 (see chart below). Although somewhat improved from the low point in January 2015, oil prices are still far below their long term average (here calculated since June 2008) of $92.03 per barrel.

The nosedive in oil prices, June 2014 through December 2014, was almost as severe as that seen in 2008, a period of severe global economic contraction. But what happened this time? Price changes occur primarily because of changes (or the expectation of changes) in supply and/or demand - and in 2008 declining demand,especially in the developed world, was a big factor. For the second half of 2014 the story is a mix of demand and supply dynamics. The U.S. has increased its capacity to self-supply oil, while a sluggish economic performance in Europe has reduced demand from that region. Consequently, foreign suppliers of oil must now compete in a smaller market.

To date, key player OPEC has not reduced production limits as a way to ring out the excess global supply. Until reduced demand for oil is matched with reduced supply, we are likely to have a Spindletop-like dynamic persisting in the U.S. Energy Sector.

 

[1] Data from the Texas State Historical Association’s Texas Almanac accessed on 7/13/2015 at: http://texasalmanac.com/topics/business/oil-and-texas-cultural-history

 

 

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