This week, Citi Research took a sledgehammer to forecasts for the oil price and energy-related equities.
In terms of the West Texas Intermediate crude oil commodity benchmark price, Citi now expects an average of $55 (U.S.) through 2015, down from $72 previously. For the companies Citi covers – mostly U.S. names, with some Canadian stocks including Canadian Natural Resources Ltd. – this translates into an expected 57 per cent year-over-year decline in earnings per share.
Citi's chief U.S. market strategist Tobias Levkovich notes that while earnings forecasts for energy companies have already been reduced, further cuts are likely in store.
"Bottom-up consensus shows more than 20 per cent declines being forecast currently [for 2015 profits]. Numbers may have to slide as much as 30 per cent [further] if there is no recovery in energy futures in the next few months."
The first chart shows the basis for Mr. Levkovich's view. The year-over-year performance of WTI crude has historically predicted the earnings growth in the energy sector for the subsequent 12 months. (On the chart, the WTI price has been pushed forward by one year to better show the trend.) In simple terms, the oil price's 46 per cent decline for the 12 months ending Dec. 2014 suggests that, when earnings are reported for 2015, the S&P 500 Energy index will show an approximate 46 per cent drop in profits.
The second chart shows that the same trend is evident for the Canadian energy sector. (Note that the crude price has been converted to Canadian dollars and pushed forward 12 months). The pattern suggests that the next twelve months will see profits for domestic energy companies fall over 40 per cent from current levels.
Importantly, not every company in the S&P/TSX Energy index will see profits dip by the same amount. Some, like Crescent Point Energy Corp., have hedge positions which lock in higher selling prices for the first half of 2015. As a result, these companies will not be as hard hit by lower market prices.
It's also true that energy companies will do everything in their power – with measures like cutting staff, reducing investment and even slashing executive travel – to offset the loss of revenue from lower oil prices.
Investors should, however, heed the work of Mr. Levkovich and be prepared for further reductions in earnings estimates for most domestic energy stocks.