Comment: Investment strategies in uncertain times
The fall in crude oil prices has had consequences even for the strong and thriving economies of China and India, according to Colin Chapman, president of Euro Petroleum Consultants
Predicting the prospects for crude oil price in the short- and long-term has been one of the major issues for national and private oil and gas companies, investors, governments and financial analysts for almost two years now – since the slump in the price in 2014. As a wise man once said, “It’s always difficult to make predictions, especially about the future.”
No-one has been fortunate enough yet to predict the future price for oil. Opinions vary from $20 in 2017 to return to $60 (more optimistic forecasts of $80 to $100 in a year do not seem to appear in reports anymore). Therefore, oil companies have been struggling to plan their budgets to minimise the losses that are inevitable when operating in unstable conditions. Pricing of $20 for crude in strategic plans creates a need to substantially cut the costs and produce more, whereas $40 to $50 suggests a greater profit within the same preconditions, but creates the threat of not meeting budget targets if the oil price turns out to be lower.
Factors contributing to crude price should be taken into account. Most of the crude oil trade contracts are transacted in US dollars, and appreciation of the currency negatively impacts the oil price worldwide. It is important, therefore, to take measures that may impact the strength of the dollar into account.
Initially, oil prices started their downward trend due to the increasing supply from the US, increased productivity of drilling, geopolitics, easier access to funds for E&P companies, and so on.
The fall in crude prices has even had consequences for such thriving economies as China and India. Many private companies in India, such as OIL, RIL, and Cairn, lost from 9% to 97% of net income in the first quarter of 2016 compared to the same period in 2015. The biggest loss was reported by RIL, from INR 10.4bn ($2.8bn) to INR 320mn ($87.1mn). Only ONGC managed to show some revival, with a 14% increase. Most of the decrease was due to subsidies reductions.
The six largest upstream oil operators registered a significant decrease of profits last year, which led to a drop in investor confidence, and their market capitalisation reportedly fell by more than $200bn collectively. Even though these companies try to cover repayments and keep up with dividends, Chevron, Shell and ExxonMobil reduced the amount under a buy-back programme so that they will stay the course for 2016-2017 within the low-price environment.
Cutting production costs doesn’t necessarily mean reducing production rates. Chevron reduced capital expenditure by 24% compared to 2015 and expects an increase in production of 13-15%, and ConocoPhillips will cut its investment programme by the same percentage, but expects a more modest increase in production of just 1-3%.
Companies that have integrated operations with the downstream sector, refining and petrochemicals, have seen a less significant impact from the lower crude prices than those that depend solely on crude production for revenues.
Surprisingly, average operating margins for US-based upstream companies increased by around 15-16%, although the EBITDA margin for smaller companies fell considerably in the third quarter of 2015 – by 31% for Pioneer Natural Resources, 51% for EQT, 75% for Devon Energy, and 250% for Apache.
Cashflow analysis showed an average decline of 25% in generated cash in the same period. As a result, analysts are already calling the trend a “cash crisis”.
The market for mergers and acquisitions also plummeted last year by 22%. Some major prospective acquisitions were cancelled due to uncertainty and volatility of commodity stocks, as well as the inability of bidders to agree upon a fair price for assets. IHS predicts consolidation and integration trends in E&P to continue this year and next, despite the fact that the worldwide deal count in 2015 reached the lowest level in the current decade.
After OPEC’s outlook for the future of the energy industry was announced at the end of last year, we saw diverse opinions about whether OPEC countries would reduce the amount of produced crude in order to prepare for substitution of oil in 2040 or would, on the contrary, raise production before demand for oil falls. Their strategy will affect other major producing countries, such as Brazil, Russia and the Middle East region, because it is neither profitable for them to continue to export oil if there are no consumers, nor to cut production when competitors increase their production levels.
The destiny of shale oil highly depends on the decision of the US to develop and invest in new, advanced technologies. At the moment, they require a very high price for oil, or a profit from other activities, such as refining, to cover costs for shale oil production and development, with the hope that these types of projects will become economically viable in a longer planning timeframe. The same applies to renewable energies – regions such as Africa, parts of Asia, South America, and Europe, which possess all the necessary resources for solar, wind, or tidal energy, or for the production of biofuels, have to make this choice right now, and this will influence crude prices in the longer term.
About the author
Colin Chapman is the president of Euro Petroleum Consultants.