Avery Wealth Blog

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In the Headlines-February 27th, 2015

In The Headlines

Is the World Headed for $10 per Barrel Oil?

At about $50 a barrel, crude oil prices are down by more than half from their June 2014 peak of $107. As dramatic as that seems, they may fall more, perhaps even as low as $10 to $20. U.S. economic growth has averaged a modest 2.3% a year since the recovery started in mid-2009. Growth in China is slowing, is minimal in the euro zone, and is negative in Japan. Throw in the large increase in U.S. vehicle gas mileage and other conservation measures and it becomes clear why global oil demand is weak and might even decline. At the same time, output is climbing, thanks in large part to increased U.S. production from hydraulic fracking and horizontal drilling. Based on the latest data, U.S. output rose by 15% in the 12 months through November from a year earlier, while imports declined 4%.

Something else figures in the mix as well: The eroding power of the Organization of Petroleum Exporting Countries (OPEC) cartel. Like all cartels, OPEC is designed to ensure stable and above-market crude prices. But those high prices encourage cheating, as cartel members exceed their quotas. For the cartel to function, its leader, Saudi Arabia, must accommodate the cheaters by cutting its own output to keep prices from falling. But the Saudis have seen their past cutbacks result in market-share losses. So the Saudis, backed by other Persian Gulf oil producers with sizable financial resources—Kuwait, Qatar, and the United Arab Emirates—embarked on a game of chicken with the cheaters. In November, OPEC said that it would not cut output, sending oil prices off a cliff. The Saudis figure they can withstand low prices for longer than their financially weaker competitors, who will have to cut production first as pumping becomes uneconomical.

What is the price at which major producers grow cautious and slash output? Whatever that price is, it is much lower than the $125 a barrel Venezuela needs to support its mismanaged economy. The same goes for Ecuador, Algeria, Nigeria, Iraq, Iran, and Angola. Saudi Arabia requires a price of more than $90 to fund its budget. But it has $726 billion in foreign currency reserves and is betting it can survive for two years with prices of less than $40 a barrel. Furthermore, the price when producers bail out is not necessarily the average cost of production, which for 80% of new U.S. shale oil production this year, will be $50 to $69 a barrel, according to Daniel Yergin of energy consultancy IHS Cambridge Energy Research Associates. Instead, the “grow cautious” point is the marginal cost of production, or the additional costs after the wells are drilled and the pipes are laid. Another way to think of it: It is the price at which cash flow for an additional barrel falls to zero.

Last month, energy research organization Wood Mackenzie found that of 2,222 oil fields surveyed worldwide, only 1.6% would have negative cash flow at $40 a barrel. That suggests there will not be a lot of “growing cautious” at $40. Keep in mind that the marginal cost for efficient U.S. shale-oil producers is about $10 to $20 a barrel in the Permian Basin in Texas and about the same for oil produced in the Persian Gulf. Also consider the conundrum financially troubled countries such as Russia and Venezuela find themselves in—they desperately need the revenue from oil exports to service foreign debts and fund imports. Yet, the lower the price, the more oil they need to produce and export to earn the same number of dollars, the currency used to price and trade oil.

With new discoveries, stability in parts of the Middle East, and increasing drilling efficiency, global oil output should rise in the next several years, adding to pressure on prices. U.S. crude oil production is forecast to rise by 300,000 barrels a day during the next year. Even though the drilling rig count is falling, it is the inefficient rigs that are being idled, not the horizontal rigs that are the backbone of the fracking industry. There is also Iraq’s recent deal with the Kurds, which means that another 550,000 barrels a day will enter the market.

While supply climbs, demand is weakening. OPEC forecasts demand for its oil at a 14-year low of 28.2 million barrels a day in 2017 which is 600,000 less than its forecast a year ago and down from current output of 30.7 million. It also cut its 2015 demand forecast to a 12-year low of 29.12 million barrels. Meanwhile, the International Energy Agency reduced its 2015 global demand forecast for the fourth time in 12 months by 230,000 barrels a day to 93.3 million, and sees supply exceeding demand this year by 400,000 barrels a day.

Although the 40% decline in U.S. gasoline prices since April 2014 has led consumers to buy more gas-guzzling SUVs and pick-up trucks, during the past few years consumers have bought the most efficient blend of cars and trucks ever. At the same time, slowing growth in China and the shift away from energy-intensive manufactured exports and infrastructure to consumer services is depressing oil demand. China accounted for two-thirds of the growth in demand for oil in the past decade. So look for more big declines in crude oil and related energy prices.

Volvo’s Campaign Gears Up to Re-enter the U.S. Market

With its revamped XC90 getting ready to hit U.S. dealerships this summer, Swedish automaker Volvo is using guerrilla tactics to reintroduce itself to the U.S.

For automobile enthusiasts of a certain age, a first glance at the grille and flowing lines of a 2015 Volvo XC90 luxury sport utility may evoke vague, pleasant recollections of a classic sports car from the 1960s, the Volvo P1800. In an era when Scandinavian furniture was all the rage, the P1800 came to epitomize Swedish automotive design. The P1800 sports coupe helped to usher in a parade of Volvo models in the U.S., sedans known for safety, practicality and ruggedness. The brand gained worldwide renown, attracting the Ford Motor Co. to acquire Volvo Cars in 2000 for $6.45 billion. Fallout from the global financial crisis forced Ford’s sale of Volvo to the Geeley Group of China for $1.8 billion.

Five years after the company’s purchase by Geeley, the XC90 today represents Volvo’s determination to recapture the brand’s American popularity, where its roughly 300 retail dealers have been nearly despondent as they wait for new models. Consumers seeking a rugged, sensible car from abroad increasingly have chosen Subarus, which today outsell Volvo 10-to-1 in the U.S.

Last year, Volvos U.S. sales were about 57,000 units, down almost 8% from a year earlier in a market that was up nearly 6% from 2013. At its peak in 2004, the company sold about 139,000 cars in the U.S. By 2020, Volvo hopes to sell 800,000 cars globally, compared with 466,000 last year, which was a record high driven by sales in China. “A lot of people grew up in Volvos. We’re not a damaged brand,” said Bodil Erikson, a Swede who is chief marketing officer in the U.S. “We’ve fallen out of mind.”

Geeley, a maker of cars and other goods, has put its financial muscle behind an $11 billion capital program to launch a new era of vehicles, starting with the large SUV built on an architecture it calls SPA, which stands for scalable product architecture. The first generation XC90, introduced in 2002, was a phenomenal success story for Volvo. Ford, in fact, admired the vehicle’s engineering so much that it borrowed XC90’s mechanical underpinnings to create its Taurus large sedan, which uses Volvo-designed innards to this day. The new XC90 was designed to convey “Scandinavian authority” and “understated confidence,” according to its chief designer Tisha Johnson. The selection of materials and the shaping of surfaces throughout the car were inspired by objects like the Wegner lounge chair and Orrefors crystal vases.

In three versions, starting in price at about $49,000 and ranging up to about $55,000, XC90 will compete against large luxury SUVs like the Audi Q7, BMW X5, Acura MDX, Mercedes-Benz M Class, and Infiniti QX60. Volvo executives report the automaker will replace seven of its sedans, station wagons, and crossovers during the next four years—a promise that should warm the hearts of its dealers.

Because the Volvo brand has shrunk in size over the last decade, it can’t match competitors with advertising buys such as a multimillion dollar commercial during the Super Bowl. Grey Group, its advertising agency, instead devised a guerilla Twitter campaign during this year’s game and another tied to the Academy Awards ceremony. More advertising will come toward summer, when the cars arrive at dealerships. The automaker’s Chinese owners are staying quietly in the background, at least for the moment, allowing Volvo’s Swedish heritage and image to shine.

1. http://bv.ms/1L6SolT – Bloomberg
2. http://for.tn/1D9iwc4 – Fortune

The Good News Is . . .

• The number of Americans filing new claims for unemployment benefits fell more than expected last week, offering fresh evidence that the labor market was gathering steam. Initial claims for state unemployment benefits dropped 21,000 to a seasonally adjusted 283,000 for the week ended Feb. 14, the Labor Department said on Thursday. The economy has added more than a million jobs over the past three months, a performance last seen in 1997. A key measure of labor market slack—the number of job seekers for every open position—hit its lowest level since 2007 in December.

• Rackspace Hosting, Inc., a leading provider of web hosting and cloud services, reported earnings of $0.26 per share, an increase of 85.7% over year-ago earnings of $0.14. The firm’s earnings topped the consensus estimate of analysts by $0.07. The company reported revenues of $472.4 million, an increase of 15.8%. Management attributed the company’s results to strong growth in its cloud services segment.

• Fairfax Financial Holdings of Canada has agreed to buy the specialty insurer Brit for $1.88 billion in cash. Brit is a member of the Lloyd’s of London insurance market, in which syndicates of specialist companies join together to share the risk in underwriting policies. The deal is expected to expand Fairfax’s presence in the Lloyd’s marketplace, complement Fairfax’s existing operations and help diversify its risk portfolio. Under terms of the offer, investors will receive $4.68 in cash for each share of Brit they hold.

1. http://www.dol.gov/ui/data.pdf – U.S. Dept. of Labor
2. http://www.cnbc.com/id/18080780/ – CNBC
3. http://bit.ly/1we99Zr – Rackspace Hosting Inc.
4. http://nyti.ms/1D9w5sf – NY Times Dealbook

Planning Tips

Tips for Alternative Ways to Fund Long Term Care

While long-term care insurance is one way to fund long-term care expenses, it is not the only option. Policies can be expensive, unavailable (to those who are not healthy enough to purchase them), and many potential purchasers object to the use-it-or-lose-it nature of long-term care insurance. Long-term care expenses can also be financed through a variety of newly developed “hybrid” products. Below are some of the alternative methods you can use to fund your long-term care expenses. It is a good idea to consult with your financial advisor to help you establish your long-term care funding plan.

Life insurance with a long-term care rider – One such product seeing tremendous growth and adoption is the life insurance policy that offers tax qualified long-term care riders. These hybrid life insurance and long-term care policies give the policy owner access to the majority of the death benefit if long-term care services are needed. If long-term care services are not needed or all of the death benefit is not used up to pay for long-term care expenditures, the remaining death benefit is paid out to the beneficiaries upon the death of the policy owner.

Annuities with long-term care benefits – Some annuities now offer tax qualified long-term care benefits. Certain companies now offer fixed annuities with long-term care riders, which enable you to invest the money you might have saved for long-term care into a product that provides a fixed income but also will provide higher payouts if you need long-term care benefits. In some cases, these types of products will double or triple the annuity payment when long-term care is needed. Additionally, these products can be purchased with a single lump sum payment which might be preferable to long-term care insurance which generally requires life-time payment of premiums and the possibility that premiums will rise significantly (which has occurred with some policies over the past few years). If the long-term care benefit is not needed, benefits are available for other purposes.

Exchange your life insurance or annuity product for a hybrid – If you own an existing life insurance or annuity product, you might be able to exchange that policy for a hybrid product that offers a long-term care benefit or for a standalone long-term care insurance policy. The Pension Protection Act of 2006 allowed for 1035 exchanges of traditional life insurance and annuity products to hybrid long-term care policies. For example, the life insurance policy could be 1035-exchanged for a long-term care insurance policy without having to pay taxes on the buildup of value inside of the life insurance policy. Ultimately, this type of exchange eliminates the taxable gain inside the annuity or life insurance policy because the qualified long-term care insurance policy allows for tax-free payouts for qualified expenses.

Traditional income annuities – Income annuities have the advantage of paying out income whether or not long-term care is needed. Life annuity income can be purchased over time during retirement to build an income source later in retirement when long-term care needs are likely to occur. The advantage of buying annuities over time is that you do not have to lock into the strategy entirely, if health or economic status changes. Another option is the deferred income annuity, in which a specified monthly annuity amount is purchased at a younger age (50’s or 60’s) with the intention of beginning benefits later in retirement (80-85). This type of annuity can provide significant income at a relatively low cost because of the extended deferral period and the fact that annuities that begin at a later age have a much higher payout rate due to the shorter payout period.

Reverse mortgage – Reverse mortgages can provide another option to pay for long-term care expenses. Reverse mortgages can pay out in the form of a lump-sum benefit, monthly payment, or a line of credit. The loan does not have to be repaid until the last homeowner borrower leaves the home. As such, a reverse mortgage does not necessarily help someone who ends up in a nursing home as the home will likely need to be sold to pay off the reverse mortgage. However, if an individual needs long-term care services in the home, a line of credit reverse mortgage might be an appropriate way to pay for this care and remain in the home.

1. http://1.usa.gov/1z9qLjG – LongTermCare.gov
2. http://bit.ly/1MMjZdZ – Kiplinger
3. http://onforb.es/1ha4KJv – Forbes
4. http://bit.ly/1D0FFek – US News & World Report
5. http://1.usa.gov/1oDiaoP – NIHSensorHealth.gov

Please don’t hesitate to give us a call if you need help with any component of your financial planning.

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Avery Wealth, Inc.
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