(The) Boring Investor

Is the drop of essential oil price since Jun 2014 a cyclical decline or a structural change? This relevant question has important implications, as it impacts whether Oil & Gas (O&G) stocks, which have been beaten down severely, are bargains. If it’s a cyclical decline, it is a matter of time before oil price recovers to higher levels and good business returns to the O&G companies. However, if it’s a structural change, the nice old business might never get back to a few of the O&G companies again.

For an extended time period prior to the essential oil crash in Jun 2014, Saudi OPEC and Arabia had been moderating essential oil price, increasing production when essential oil price was favourable and cutting back when oil price was declining. This worked well, so long as other oil producers cannot take advantage of OPEC’s cutback and increase their own production. Things transformed with the shale essential oil revolution in the US, which increased US’ oil creation to 9.2 million barrels each day (mb/d) as at Mar 2016, almost matching Saudi Arabia’s creation of 10.2 mb/d (source: Oil Market Report). The greater OPEC slashes on production back, the more its rivals shall step in to take market share from OPEC.

In the long run, this is not lasting as OPEC will eventually lose market talk about to other manufacturers progressively. Thus, in Nov 2014, Saudi Arabia and OPEC made an important decision never to cut production any longer to aid oil price. Oil price fell precipitously as a result. The price war is not without cost to Saudi Arabia and other OPEC members. Fig. 1 below, extracted from a World Bank or investment company research notice in Mar 2015, implies that OPEC makers derive a great proportion of income from oil creation.

Fig. 2 below, from the same research take note, demonstrates the fiscal break-even price of oil, i.e. the price at which government revenue balances expenditure evenly, is often as high as USD100 per barrel for many OPEC suppliers. At the existing essential oil price of USD45, many OPEC companies have difficulties funding their public costs and need to drop into their previous reserves.

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Thus, though it is in Saudi Arabia’s long-term passions to sustain the purchase price battle and reduce competition, there are short-term transitional aches to be addressed. To boost its ability to sustain an extended battle price and protect its market share in the foreseeable future, Saudi Arabia has made long-term plans to lessen its reliance on essential oil revenue and lock-in market talk about.

2 Trillion Megafund for Post-Oil Era). Another key step to lock-in market talk about is its growth of refining capacity. Already, Saudi Aramco has equity stakes in oil refineries worldwide with a refining capacity of 5.4 mb/d. These refineries give a ready buyer because of its crude oil. It programs to increase this to 8-10 mb/d (see Saudi Arabia rewrites its oil game with refining might).

At 10 mb/d, it is almost equal to Saudi Arabia’s current essential oil production of 10.2 mb/d. When that happens, it no more needs to battle for market tell other oil suppliers. Returning to the initial question of whether essential oil price is within a cyclical drop or structural change.