The Take

Oil’s Giant Drop31/08/16

QUTEFS’ new Publication Director, Nate Hentschel, discusses the tumultuous global oil industry and what might be coming next for the commodity market in this edition of The Take:

The oil industry has historically been, by its very nature, a volatile and cyclical market. Crude oil prices have had a tremendous fall in the last two years, dropping over 60% from around this time in 2014, where oil had been trading at over $90 per barrel, to a current price of under $50.

This drop in price has put pressure on the global oil industry, with many businesses experiencing significantly lower profits. Some of the less conventional oil fields, such as those in the United States which aggressively pursued fracking, have become entirely unprofitable at current oil prices. The price drop has also caused many of the major global oil players such as BP, Royal Dutch Shell and Exxon Mobil to scale back exploration and development of new wells.

The major concern for many companies over the past two years has not been profitability. Rather, many producers have found themselves excessively leveraged as they hurriedly established funding facilities to bring future supply to the market at its historical highs. A deflation in prices saw a decline in the coverage ratios amongst these opportunists and depressed capital expenditure. Many smaller producers were unable to survive as a lack of capital inhibited their ability to begin exploration projects, achieve production efficiencies or execute acquisitions.

A consolation for these producers, albeit a minor one, is that they weren’t the only ones floored by the oil downturn. Major economies, like Russia, Venezuela and Saudi Arabia have experienced major disruption as a result of the fall in prices. The Saudi government has even been forced to dip into banked profits from the crude peak in order to fund government expenditure. A prolonged period of suppression will likely require Saudi Arabia to reassess their fiscal strategy and constrain public investment spending.

The price of oil is a prime example of the powers of supply and demand on a global level. Crude oils’ demand profile is relatively inelastic, owing to its role as an input for most forms of production, as well as its refinement capabilities for fuel across most forms of transport. The depression of prices since late 2014 is largely attributable to significant increases in supply, as producers rushed reserves to the market during its peak. Political factors are also expected to impact the playing field as a reduction in Iranian trade sanctions should see the supply increase further.

The news isn’t all gloom for oil, however. On the consumer end, the price of petrol has reduced significantly, and the overall cost of transporting goods has also dropped. This is great news for oil-dependent organisations, such as Qantas, who recently posted their best result in nearly a century on the back of $490 million saved on fuel expenses.

While there are numerous causes for the oil price collapse, the question many have been considering is; when will the price rise? While some analysts have been predicting a steady rise in price over the next year, this author believes that the unique economic and political environment we are operating in globally is going to keep downward pressure on oil prices for the foreseeable future. Given the surplus of oil already in the market, the entry of Iran with lowered trade sanctions, and the OPEC pursuit of high output, I would be surprised if the oil price returned to pre-2015 levels any time soon.

So that’s our take on the oil industry as it stands today. Watch this space for more QUTEFS content.