The Missing Link Between Oil Price & O&G Profitability

50 per barrel recently. Yet, there is a continuous stream of bad information from Oil & Gas (O&G) companies. 283 million at exactly the same time and Technics Oil & Gas going into judicial management lately. Is the disparity between oil price recovery and bad news from O&G companies simply a lagging effect or are there various other factors unaccounted for?

The response to the question above is both. Why don’t we tackle the more fundamental question first. Even though fortunes of O&G companies are linked with oil price, the relationship is not just a direct one for some companies. Only companies that get excited about oil exploration and creation (E&P) such as Kris Energy and Interra Resources have a direct relationship with oil price.

These E&P companies produce and sell essential oil on the market. Any change in oil price has a direct impact on their success. The majority of the O&G companies listed on Singapore Exchange, however, do not produce oil. Instead, they provide equipment and services such as Offshore Support Vessels (OSVs) to the E&P companies. Thus, from the relationships above, the fortunes of shipyards are influenced by the OSV companies, which in turn are influenced by the E&P companies, which in turn subsequently are influenced by the oil price.

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I reproduce this diagram from Marina Money Offshore to demonstrate the 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 essential oil price, but also the spending finances of E&P companies. Oil price has been discussed previously in The Demand and Supply for Oil and Understanding Saudi Arabia’s IDEA on Oil Price. This post goes the conversation downstream to the E&P sector that includes a greater impact on the profitability of OSV companies and shipyards than essential oil price.

70 Billion Next Year (i.e. 2016)), even though essential oil majors have reported better than expected cash flow in 1Q2016 due to their downstream operations (see Oil’s Profit Surprise Has Analysts Wondering How Well Exxon Did). In my opinion, if oil price were to recover to higher levels even, essential oil majors will be very cautious in increasing spending finances to previous levels after going through such a hard 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 irrespective of price, oil price will probably are more volatile and oil majors will probably become more traditional in their capital expenditure.

All these mean that while some business will return, the nice old roaring business is not going to return for a few of the OSV shipyards and companies. 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 definitely a lagging effect between higher oil price and improved profitability of O&G companies. However, from the dialogue in the previous paragraphs, it is likely to take a pretty long time before we see higher success for O&G companies.

In the meanwhile, it continues to be downhill predicated on E&P spending budgets and you could be prepared to see more bad information from the O&G companies. Just a reminder, I am no expert in O&G. I am only an buyer looking to work my way out of the O&G clutter in my portfolio. It really is a fight that no self-confidence is experienced by me of winning.

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