Impact Of Fed’s Interest Rate Decision On Oil Prices And Related Industries

The much awaited decision of the US Federal Reserve regarding the interest rate hike is finally out. Yesterday, the US Central Bank announced its decision to maintain status quo, that is to say, that it will not raise the interest rates for now, as the economy requires further improvements in the labor market and inflation before the bank hikes the rates for first time since the economic recession. Though there is a possibility of a rise before the end of the year, the news came as a relief to the commodity market participants, who had been watching the decision very closely. The WTI oil prices did not tumble much due to the announcement and fell merely 25 cents to close at $46.90 per barrel, while the Brent oil prices were down 50 cents, closing at $49.08 per barrel on Thursday (Source: Bloomberg). The market had expected oil prices to witness a downward drop in case the Fed decided to announce a hike in the interest rate. Let’s look at the implications of the Central Bank’s decision on the oil prices and the related industries.

Source: Bloomberg

The market has a mixed opinion about the news. While some of the market experts believe that the no-change decision will support the commodity market, others see it as a warning bell. Some of the analysts view the news as a positive one for the crude oil prices as a rate hike could have triggered volatility in the oil prices. This is because higher interest rates could strengthen the US dollar against other currencies, making crude oil supplies more expensive and reducing the demand for oil further. In contrast, some industry specialists are of the opinion that the Central Bank’s decision to leave the interest rates unchanged is influenced by the slower-than-expected economic growth in the Chinese economy and the impact it could have on the US as well as global economies.

However, in our opinion, the decision has managed to prevent the commodity market from experiencing another wave of instability and will allow the dynamics of the OPEC and Non-OPEC countries to drive the oil prices. Further, we expect the oil prices to recover over the next few months, when the oil refineries shut down for their annual maintenance, and the supply glut eases to some extent. Thus, we figure that the Fed’s move will be favorable for the oil prices at least in the near term. Now, look at the impact of the decision on some of the industries that are closely linked to oil prices.

Exploration and Production (E&P) Companies

The oil and gas producing companies in the US have been the worst effected by the plunge in commodity prices over the last one year. Since the commodity prices have hit their multi-year lows in the recent months, these companies have been struggling to sustain their production due to their high production costs. Thus, most of the independent E&P companies have drastically cut down their capital spending since the beginning of this year to maintain flat production till the oil prices recover. Further, the recent devaluation of the Chinese Yuan and the slower-than-expected economic growth in the world’s second largest economy, China, has added to the troubles of the industry. As a result, most of the industry players had been eagerly waiting for the Federal Reserve’s decision on interest rates to gain more clarity on the industry outlook. Now, with interest rates remaining unchanged, the commodity market is expected to see less volatility, ceteris paribus (other things being equal). However, this also means that the hard days of the oil and gas industry are here to stay at least for the next few months. The market also reacted to the news which led to an average decline of almost 2% in the stock price of most of the independent oil and gas companies such as Chesapeake Energy (NYSE:CHK), Anadarko Petroleum (NYSE:APC), and EOG Resources (NYSE:EOG).

Source: Google Finance

See Our Complete Analysis For ConocoPhillips Here

Energy Services Companies

The impact of the sluggish commodity prices has trickled down to the energy services providers as well. Since the oil and gas companies have been aggressively slashing their capital expenditure on exploration and drilling activities, energy services companies such as Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL) have seen a meaningful decline in their contract backlogs. Consequently, their stock prices have also seen a significant drop over the last one year. Thus, it would not be wrong to say that the fate of the energy services industry is positively correlated to the crude oil prices. Since the US Central Bank choose not hike the interest rates, the commodity market is likely to remain somewhat resilient in the near future. While this will not improve the bleak outlook of the oil and gas industry and, in turn, the energy services industry, it will not make things worse for both the industries to say the least, assuming everything else remains the same. This implies that the energy services industry will continue to face tough times ahead until the commodity prices improve. Most of the large energy services experienced a drop in their stock prices yesterday after the news became public.

Source: Google Finance

See Our Complete Analysis For Schlumberger Here

US Airline Industry

Of late, most of the US airlines have been minting a lot of money. While a notable part of their profits is driven by the capacity discipline followed by these airlines, a significant portion of this is attributable to the depressed crude oil prices. This is primarily due to the fact that jet fuel costs contribute more than one-third of the total operating expenses of an airline. Thus, the sharp decline in crude oil prices over the last one year has significantly contributed to the earnings of these airlines. Since the profits of these airlines are largely tied to the crude oil prices, a weak outlook of the commodity market is a positive for the airline industry. Accordingly, a rate hike, which could have resulted in much lower crude oil prices, would have been much more beneficial for the airline industry. However, the current decision is also largely positive for the US airlines as it does not improve the nebulous outlook of the oil price in any way. This was evident from the fact that most of the airline stocks increased by an average of 2% yesterday when the decision was announced.

Source: Google Finance

See Our Complete Analysis For JetBlue Here

Conclusion

While the overall outlook of the commodity market remains weak, the short term impact of the Federal Reserve’s decision is positive for the commodity prices.

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