Victors emerging in the oil price war

Oil prices have been central to market discussion in the past six months, but is the current weakness a short or long-term correction?

Victors emerging in the oil price war

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It was inevitable that prices would rise since the shock at the end of 2014 (Brent crude was at $55 per barrel with WTI crude at £49 as per 2 April). Still data from the US Energy Information Administration (EIA) reports crude inventories in the US at near an 80-year high. 
 
“This year, US crude oil inventories are building at an alarming median rate of 7m barrels per week, resulting in total commercial stocks of around 434m barrels,” says Greg Bennett, fund manager at Argonaut Capital Partners. 

Full within weeks

“According to the EIA, the total US working storage capacity is 521m barrels. At current rates, US storage capacity could be full within a few weeks is we reasonably assume only 95% of capacity is practically available.” 
 
For Bennett, the recent turmoil is a direct result of the “first price war” among energy producing nations since 1986. 
 
“While broadly positive for economic growth, the turmoil will create a new paradigm in the oil market. Crude prices will remain lower for longer – or at least until Saudi Arabia achieves its strategic aims.” 
 
If that’s the case, who stands to benefit and who will lose out? For consumers, the drop is already being felt at the pump, while on a wider country level the most apparent winners are those who import a large percentage of oil relative to the size of the economy, such as Japan, India, Philippines and South Korea. For the likes of Russia though, the negative impact is obvious. 
 
“Should the oil price stay low for the next few years, with shale remaining the ‘marginal barrel of oil’, widely diverging paths will be experienced by economies,” says Curt Custard, head of global investment solutions at UBS Global Asset Management.  

Stark choices

“Countries such as India could enjoy a huge tailwind while others such as Venezuela could face a stark choice between reform and default. That said, if low prices and the elasticity of shale cause inelastic new supply to be abandoned whilst demand picks up, then the world could face a shortage and a very different oil price later in the decade.”
 
On a sector level, the winners in an oversupplied oil market could be businesses involved in downstream operations. For Bennett, oil refiners are enjoying favourable conditions; so long as the price of crude (input costs) falls more than the price of refined products (revenues). 
 
“These businesses have significant storage capacity and can buy and lock in low front month prices, thereby boosting margins and profits,” he explains.
 
“In response to the 1986 oil price collapse, the upstream industry cut capex and jobs to protect cashflows. The oil majors cut capex by an average of 24%; some cut capex by up to 39%. Reduced upstream activity also led to excess capacity in the oil services industry, causing further job cuts and weak pricing as companies adopted discounting to stay competitive.”
 
“Interestingly, downstream activities – particularly refining businesses – enjoyed bumper profits during this period. This helped offset the decline in upstream revenues for the majors. Today, downstream assets and their revenues are mere footnotes for most energy investors.
 
“However, this supply-led shake-up of the oil markets, which has not been seen for almost thirty years, may once again create opportunities for businesses, which for a long time, have been ignored.”
 
 

 

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