Falling Crude Oil Prices Could Begin To Hurt Caterpillar

Caterpillar’s (NYSE:CAT) revenue has already been suffering from a decline in its Resource Industries segment due to weak demand for machinery and equipment in the global mining sector since the fourth quarter of 2012. Now, to add to its woes, crude oil prices have declined to a level where Caterpillar’s (CAT’s) Energy & Transportation segment may begin to feel the pinch. This is a cause for concern for the company, since Energy & Transportation was the only segment that it could rely on for growth in the short term, as the company’s Construction Industries segment also took a dive in the third quarter due to poor sales in Brazil. CAT’s Energy & Transportation segment will also feel the heat in the coming year from lower sales of locomotives in the U.S.

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Crude prices drop to possibly unsustainable levels

During its recent quarterly earnings meet, CAT touched upon the impact of the declining crude price on the overall oil & gas industry. According to CAT and its customers, crude oil price within the range of $80-$90 was sustainable for production. However, low 70s “would bring a chill across the market” and will likely impact CAT’s business. ^[1] On Wednesday, November 19, 2014, crude oil prices moved to reach that level when light sweet crude futures on the New York Mercantile Exchange closed below $75 per barrel for a December delivery.

Things aren’t looking particularly good for crude oil prices in the near future considering that a recent report by the U.S. Energy Information Administration (EIA) revealed results completely contradictory to market expectations. According to the EIA, for the week ended November 14, U.S. crude supplies increased by 2.6 million barrels, compared to market expectations of a decline of 660,000 barrels. ^[2] Apart from growth in production in the U.S., global crude oil supply is also receiving a boost due to the unwillingness of the Organization of the Petroleum Exporting Countries to lower their output, fearing that it will negatively impact their market share. On the demand side, China, the largest oil importer in the world, is likely to import less in the near term given that its GDP growth is expected to decline from 7.7% in 2013 to 7.3% in 2014 and 7.1% in 2015.

With a significant demand supply mismatch, we do not expect to see an increase in crude oil prices any time soon. This certainly sparks a concern for CAT, whose sales to the oil & gas industry account for more than 25% of its Energy & Transportation revenue and also a considerable portion of its Construction Industries revenue. If crude oil prices continue to remain at the present unsustainable levels, many of CAT’s oil & gas industry customers may have to shut shop, which will have a negative impact on CAT’s revenue.

Caterpillar could suffer due to delayed response to locomotive emissions requirements

U.S. railroads have been looking for new locomotives or retrofit kits for existing locomotives that would help them remain compliant with the latest emissions standards, which will come into effect from January 2015. This would have been a great growth opportunity for CAT’s Energy & Transportation segment, which also manufactures locomotives, if it would have been able to offer the railroad industry with the required locomotives.

CAT had announced that it will not have emissions-compliant locomotives ready for production anytime before 2017. It anticipates its demonstration models to be available only by next year. By the time CAT will be able to deliver production ready units, General Electric (NYSE:GE) will already have captured a large chunk of the market. GE has already begun testing its locomotives for compliance with the latest emission standards and should be able to provide emissions-compliant locomotives by next year. This loss of market share could be a significant blow for CAT, 70% of whose locomotive revenues are generated through sales to the U.S. railroad industry.

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1. Caterpillar’s (CAT) CEO Doug Oberhelman on Q3 2014 Results – Earnings Call Transcript, October 23, 2014, www.seekingalpha.com [↩]
2. Weekly Petroleum Status Report, November 19, 2014, www.eia.gov [↩]