The current global oil market holds different prospects for different sets of stakeholders. For oil producers as well as investors exposed to oil, there is the need for re-evaluation; and for consumers, it is the need to seize the day.
The sustained slump in global crude oil prices has wreaked havoc on many oil producers as well as investors exposed to oil. North American tight oil producers accounted for the marginal increase in global supply, which led to the current overhang. Following the decision by the Organization of the Petroleum Exporting Countries, OPEC, led by Saudi Arabia, not to curtail output, U.S. (shale) operators as well as other higher-cost producers came under intense viability pressures. However, by idling more than half their drilling rigs, migrating to higher-yield zones and employing higher-efficiency methods, the shale operators were able to “buy some time”; but with oil prices falling below US$40/barrel and hedges expiring, those pressures have been renewed and the concern is that this time, the effect may be more disastrous.
Exposure
Energy stocks, particularly oil and gas, have taken a few hits over the last one year. More uncertainties associated with market fundamentals as well as climate and environmental issues may add to investment concerns.
According to Bloomberg, more US oil and gas companies have filed for bankruptcy this quarter, than in any other since the great depression. In 2016, even more companies are expected to join that group. These Chapter 11 bankruptcy filings are meant to protect the companies from creditors while they restructure; but with oil prices projected to remain low in the near term, it is unlikely many ― if any ― of the companies will be resuscitated.
United States banks that have lent to oil and gas companies have also come under scrutiny. Some financial analysts have warned that there is currently a greater danger of default than last year. With oil prices hitting the lowest levels in more than a decade, U.S. banks have come under even more pressure. In the light of banks’ exposure to other asset classes with falling prices, the next Federal Reserve’s financial stress tests would only add to that pressure. Oil-producing countries are not left out of the crunch. Buffeted by dwindling petroleum revenues, Sovereign Wealth Funds in the Persian Gulf have withdrawn funds from asset managers at a record rate this year, sparking concerns about managers’ profits. Saudi Arabia, OPEC’s largest producer has just announced a budget deficit of US$98 billion for 2015; and the budget for 2016 has been cut by 14%. With oil accounting for about 75% of her foreign exchange earnings, an estimated budgetary breakeven oil price of about US$105 per barrel suggests the country is set for some strategic economic readjustment.
Integrated Oil Companies ― especially the larger ones ― may find some relief in the benefits of the complete oil and gas value chain but are still bracing for further restructuring in 2016. The segment operators however may be more exposed. Operators in the upstream (Exploration and Production) segment for example, are grappling with plunging oil prices that may endure for the near term, while some midstream (Transport) and downstream (Refining and Marketing) segment operators face changes in the factors that underpin their business models.
Windows
Reducing one’s exposure to oil and gas may be reasonable when prices are declining but may leave one wanting when they rebound. Even tenuous markets may still hold investment windows.
On the plus side, lower commodity prices, especially oil and gas, tend to spur economic activity in energy-importing countries or those with energy-dependent output. Investors may find single-country funds a good way to access such. Low oil prices for example, have seen an uptick in sales for some automobile ― especially SUV ― manufacturers. Commodities-based economies on the other hand tend to witness currency and bond grade declines when prices fall. Canada’s energy sector for example, has been impacted by falling oil prices and her currency has seen significant depreciation against the U.S. dollar.
Emerging markets present differing investment outlooks. For Goldman Sachs, their BRIC (Brazil, Russia, India and China) Fund is being reassessed while others such as Canada Pension Plan Investment Board may be staying long. Brazil and Russia are in the main, commodities-exposed economies but India is an energy-importing country. China, which has been driving the global economy, may be experiencing slower growth, but its tech industry has seen some good performance.
All said, due diligence should be the investor’s guide.
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