Oil price has moved higher to almost US$50 per barrel recently. Yet, there is a continuous stream of bad news from Oil & Gas (O&G) companies. We had Linc Energy going to voluntary administration in Apr, Ezra reporting quarterly losses of US$283 million at the same time and Technics Oil & Gas going into judicial management recently. Is the disparity between oil price recovery and bad news from O&G companies just a lagging effect or are there some other factors unaccounted for? If it is solely a lagging effect, the gradual improvement in oil price in recent months should progressively lead to better business conditions for O&G companies and the current wave of bad news could potentially mean the worst of the slump is near. However, if it is some other factors at work, the wave of bad news might not end so quickly and the prices of O&G stocks might continue to slide. Just a disclaimer before we continue: I do not work in the O&G industry. Like many investors, I have invested and lost money in O&G stocks. The information in this post is based on information that I gathered in my attempt to recover the losses in my O&G stocks. Hence, any incorrect information is unintentional and regrettable. Do not rely on this post for your investment decisions.
The answer to the question above is both. Let us tackle the more fundamental question first. Although the fortunes of O&G companies are tied to oil price, the relationship is not a direct one for most companies. Only companies that are involved in oil exploration and production (E&P) such as Kris Energy and Interra Resources have a direct relationship with oil price. These E&P companies produce and sell oil in the market. Any change in oil price has a direct impact on their profitability. The majority of the O&G companies listed on Singapore Exchange, however, do not produce oil. Instead, they supply equipment and services such as Offshore Support Vessels (OSVs) to the E&P companies. These OSV companies include the likes of Ezra, CH Offshore, etc. Then, there are shipyards that build equipment for the OSV companies such as Keppel Corp, SembMar, Triyards, etc.
Thus, from the relationships above, the fortunes of shipyards are dependent on the OSV companies, which in turn are dependent on the E&P companies, which then in turn are dependent on the oil price. I reproduce this diagram from Marina Money Offshore to illustrate the O&G industry supply chain.
|O&G Industry Supply Chain|
Thus, to understand the fortunes of OSV companies and shipyards, it is not only necessary to know the trend of oil price, but also the spending budgets of E&P companies. Oil price has been discussed previously in The Demand and Supply for Oil and Understanding Saudi Arabia's Game Plan on Oil Price. This post moves the discussion downstream to the E&P sector which has a greater influence on the profitability of OSV companies and shipyards than oil price.
Although there are small independent producers like Kris Energy and Interra Resources, the E&P sector is dominated by National Oil Companies (NOCs) such as Saudi Aramco and Petronas and Intenational Oil Companies (IOCs) such as Exxon Mobil, Royal Dutch Shell, BP, etc. As mentioned earlier, oil price directly affects the profitability of E&P companies. In their attempt to navigate the deep and prolonged slump in oil price since Jun 2014, they have cut E&P spending budgets, jobs and deferred major projects. Such spending cuts are likely to continue (see Oil Spending Seen Down $70 Billion Next Year (i.e. 2016)), even though oil majors have reported better than expected earnings in 1Q2016 due to their downstream operations (see Oil's Profit Surprise Has Analysts Wondering How Well Exxon Did).
In my opinion, even if oil price were to recover to higher levels, oil majors will be very cautious in raising spending budgets to previous levels after going through such a difficult period. As discussed in Understanding Saudi Arabia's Game Plan on Oil Price, there are structural changes to oil price. With OPEC producing to their full capacity regardless of price, oil price is likely to become more volatile and oil majors are likely to become more conservative in their capital expenditure. All these mean that while some business will return, the good old roaring business is not going to return for some of the OSV companies and shipyards.
I mentioned earlier that there is a lagging effect between oil price and profitability of OSV companies and shipyards. Based on the industry supply chain discussed earlier, there is indeed a lagging effect between higher oil price and improved profitability of O&G companies. However, from the discussion in the previous paragraphs, it is likely to take a fairly long time before we see higher profitability for O&G companies. In the meanwhile, it is still downhill based on E&P spending budgets and you can expect to see more bad news from the O&G companies.
Just a reminder, I am no expert in O&G. I am only an investor trying to work my way out of the O&G mess in my portfolio. It is a battle that I have no confidence of winning.
See related blog posts:
- The Demand and Supply for Oil
- Understanding Saudi Arabia's Game Plan on Oil Price
- What Moving Averages Can Teach Us About O&G Stocks
Hi Chin wai,ReplyDelete
One thing, even if there is no lag and imagine there is demand for rigs n osvs, but one thing u did not address is "Do u know how many idling rigs n osvs now in the world".
So after the lag of E&P, u still need time to soak up the excess supply. Can be quite gloomy!
You're right. Thks for pointing it out!
Will take a long time to clean up! Cycle will repeat itself unless we don't need crude oil anymore.ReplyDelete
Yes, it will take a long time. It's like people being afraid of buying stocks after a major crash. It'll take some time, but people will begin to take risk again.Delete
We still see a few bubble teas surviving. Right?ReplyDelete
Definitely. The question is finding out which ones will survive the slump.Delete
from the link you can see the consolidation of drilling contractors in 1990s.ReplyDelete
Why do most of the listed OSV has a short history?
Does the business of OSV really follow oil price even with a lag?
Lastly the story of Loews Corporation purchase of Diamond Offshore is interesting and something to remember.
Thks for the links. Very informative!
Like the drilling sector before them, the OSV sector will also consolidate and recover eventually, except that we don't quite know which company will survive and which won't.
Maybe most won't if this is a long winter. 1986, someone wished for 3 or 4 companies instead of 40.ReplyDelete
Thks for the link. It is a close reflection of the current situation.
To be conservative, I'm assuming a long winter and will act accordingly.