If history can be a guide, we should not expect a recession to result from the current oil price collapse.

There are those saying the decline will either cause a recession or a stock market crash. Historical data does not support that view. We are not in recession, and U.S. stocks are not visibly in or near a Bear.

Oil and Recessions:

This chart plots the price of West Texas Crude from 1946 through the end of 2014 (68 years and 11 recessions).  The evidence is quite the opposite of the worry argument. Historical data shows that rising oil prices precede recessions, not declining oil prices.

Each major oil price rise since 1946 ended in recession. Most of the significant oil price declines occurred in periods absent of recession. The oil price declines of 1991, 2001 and 2009 occurred during recessions, not preceding them.

Prices have declined during recessions in the last few decades, but we are not in a recession. We are in weak world growth, but the U.S and world economies are still growing. We are in a condition of significant oversupply of oil with producers competing on price to maintain production volume.

Oil and S&P 500 Stock Prices:

This chart plots the year-over-year price change of the S&P 500 (or its pre-1947 precursors) versus the price of West Texas Crude from 1946.

There is no evident correlation between the price of oil and the changes in the price of the S&P 500 index. That makes it difficult based on history to suggest that the current oil price collapse will cause the S&P 500 to go into a Bear market.

Oil and Key World Events:

This chart is the same as the one on the first page, with key world events plotted on the timeline.

SOME KEY WORLD EVENTS TIMELINE

1960 OPEC Formed

1967 Suez Canal Closed

1968 Oil Discovered on Alaska North Slope

1969 Oil Discovered in North Sea

1973 Yom Kippur War / Oil Embargo/Price Control on US Oil

1979 Iranian Revolution

1980 Iran Iraq War

1983 NYMEX Launches First Oil Futures Contract

1986 OPEC & Non-OPEC Overproduction and Price Competition

1991 Desert Storm

1997 Asian Financial Crisis

2000 Dot-Com Stock Market Crash

2001 World Trade Center 9/11 Attack

2008 US Mortgage Crisis / Stock Market Crash

2011 Libyan Revolution

2014 World Oil Oversupply (incl. US Shale Boom)

Current and Near-Term World Oil Production and Consumption:

This chart from the International Energy Agency shows the current world supply of oil to be greater than current consumption, but world consumption is in a general up trend (an oversupply condition).

They further predict an equilibrium later in 2015 or early 2016. That, of course, is a matter for debate among forecasters.

The bottom line, in our view, is that for now the world economy is growing, oil supply is too high, producers are competing on price to maintain market share, and there will be a shake-out / consolidation among private producers. The big fish will eat the little (overleveraged) fish to acquire the high quality properties for future production.

For those with patient money, major oil companies with strong balance sheets and well covered dividends and above average yields may be a good way to benefit from the ultimate recovery in oil prices – maybe not to $100, but significantly higher than $45 (and a lot more if another macro event reduces production from an important country). Get paid to wait for a nice capital gain.  It may be a tad early to invest in the group now, but for long-term holders those stocks are worth a look.

In the meanwhile, don’t worry about collapsing oil prices causing a recession or stock market crash.

Linear Regression Trend Line Suggested 2016 Oil Price Targets:

One economist at the World Economic Forum said that oil may never see prices above $50 again. Trend lines suggest that is overly pessimistic.

Chart: From 1946 through January 16, 2015, the regression trend line extended to January 2016 is about $89 per barrel. That covers the period just after WW II to the current time (68 years).

Chart: From 1973 (the beginning of the Oil Embargo by OPEC) through the present time, the regression trend line extended to January 2016 is about $77 per barrel.

Chart: From 1974 (after the Oil Embargo), the regression trend line extended to January 2016 is about $71 per barrel.

In addition to these basic historical trends, major oil exporting countries need prices in the $70 to $100+ range to support their regime’s budgets. In the aggregate, they can hold out for several years (spending their sovereign wealth funds or borrowing), but eventually they need to charge more.

Additionally, much of our Shale production needs prices above the $45 to $50 level to be profitable on an “all in” basis (as opposed to marginal costs of pumping existing wells).

Overall, there are significant forces for prices well above $50 – not right away, but not far in the future either.

Where Is The Bottom Price ($40, $30, $20, $10)?

There are some forecasters suggesting a $20 or $25 bottom – not many, but some. Let’s look at $40,

$30, $20 and $10 per barrel in historical terms.

$40, $30, and $20 all have historical precedent from 1947 onward, but $10 does not.

Exxon reported a production cost in 2013 from existing wells at $11.48 per barrel. Some say Saudi Arabia may have a $5 production cost. But nobody has an “all-in” cost anywhere near $10. So that is out of the question for any sustained period.

There is major economic damage and reduced capital expenditure at the $45 that we have already seen. In the price war that is underway, the deep pockets (Saudi Arabia most notably) may be able to drive the price in the $30’s, which might “kill off” the weak hands.

The ability of Shale operations to be ramped up or down quickly and easily (compared to deep wells) may well prevent $100 oil for a long while, but as the small player are assimilated by the majors, a more organized approach to production and pricing is likely.

If one or more major oil exporting countries goes off line due to war uprisings, a spike in oil prices to high levels is quite possible. Wars and insurrections are not unlikely in many key countries.

Our belief is that the wreckage for public oil companies and national oil companies at $20 is just too hard to imagine. Maybe a momentary spike but, no more.

4 Best Overall Stocks to Bet on Oil Price Recovery/Normalization with Reasonable Safety:

It may be early to enter, but these are the four oil companies that we think make the most sense for a conservative investor wanting fossil fuel exposure, with solid current yield, strong balance sheets, and reasonable capital gains potential when oil oversupply ends and prices normalize.

MS rating 1-5 (5 best)

S&P Year Ahead 1-5 (5 best)

S&P Fair Value 1-5 (5 best)

Wright Rating (see description on QVM blog, last digit 1-20, best is 20)