Financial Analysis of Oil and Gas Market – Dec 2016

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Description: Figure 1 highlights the performance of the oil and gas companies for the month of November 2016 (x-axis) and the performance of the 11 months prior to November 2016.

2016 has been marked with challenges for the oil and gas (O&G) industry. With a history of booms and busts, the oil industry is no stranger to trying conditions, having gone through a similar cycle when oil prices went down below US$10 per barrel in 1998.

Earnings were down for companies that made record profits in recent years, leading them to decommission about two-thirds of their rigs and sharply cut investment in exploration and production. Scores of companies have gone bankrupt and an estimated 125,000 oil workers, in the United States, lost their jobs.

So why did the price drop in the first place? Simply put, it all boils down to the fundamentals -the economics of supply and demand. United States domestic production nearly doubled over the last several years, pushing out oil imports that needed to find another home. Saudi, Nigerian and Algerian oil that once sold in the U.S. was suddenly competing for Asian markets, and the producers were forced to drop prices. Canadian and Iraqi oil production and exports were rising year after year. Even the Russians, with all their economic problems, managed to keep pumping at record levels.

On the demand side, the economies of Europe and developing countries are weak and vehicles are becoming more energy-efficient. So demand for fuel continues to lag, although there are signs that demand is growing in the United States and China.

That said, oil markets have bounced back considerably since hitting a low of US$26.21 a barrel in New York in early February. A more than 50-percent jump in price in less than 12 months would constitute a spectacular year for any asset. The reason for the spectacular run-up in the last few days is OPEC committing its members to their first oil production limits in eight years. OPEC has agreed to cut production by about 1.2 million bpd, or about 4.5 percent of current production, to 32.5 million bpd.

Now the question is whether or not the recent OPEC deal will further improve the prospects for the sector going forward. Oil rigs have already begun popping up in U.S. oil fields when prices approached US$50 a barrel, and we believe high-cost producers outside OPEC will further ramp up production if crude prices rise above US$55 a barrel.

If there is anything to be concerned about, it is the non-OPEC members, such as Russia. Russia is expected to increase its crude output by 230,000 barrels a day this year and has the capability to boost production by another 200,000 barrels a day in 2017. OPEC is seeking a 600,000 bpd cut in production from the non-OPEC producers. Russia has committed, temporarily, to cut production by 300,000 bpd.

We believe it will be difficult for Russia to deliver on those cuts. The Russian government, which owns a majority share in that country’s big oil companies, would face a revolt from minority shareholders if it sought to limit production. From a technical perspective, Russia can’t turn off the taps, because much of the production comes from areas with freezing temperatures where drillers must keep oil flowing.

Further, with technology advancing at a rapid pace and renewable energy’s growing piece of the pie, 2017 could be another year of relentless global supply growth similar to that seen in 2016.