21st Century Oil-onomics


Daniel-Park-300x292When oil topped out at $145 per barrel in July 2008, pressure on goods producing nations was similarly at an all time high. The oil-producing, net-exporting members of OPEC found their countries balance sheets healthier than any time in history.

For countries who were net importers of oil and related products, these high prices caused a collapse in demand, followed shortly by a substantial fall in the oil price to $33 by February 2009 at the peak of the global recession. Oil is a story of supply and demand.

Although cheaper fuel stimulates the global economy, it could aggravate political tension by squeezing various government’s revenue streams.

Oil has been the main story of the last year, a story of Middle Eastern uprising, terrorism in the Gulf, fracking and global slowdown causing a lack of demand

Last week in an interview, the Saudi OPEC minister said “If you don’t invest in oil and gas, you will see prices at more than $200,”

Over the last few weeks, we have seen, the oil majors including BP (BP:LSE) and ExxonMobil (XOM:NYSE) begin to announce a reduction in spending on new projects from the North Sea to Alaska and as far as Siberia. As it stands with Oil at $47 per barrel, projects are being taken offline as they become uneconomical and in turn loss making.  Of all the Oil producing nations, Iran has the highest breakeven price at $130 per barrel, with Saudi Arabia and Iraq both north of $100 per barrel, the lowest is Norway, down at $40, (see table below).

Oil is a supply and demand business. Where prices are, companies begin to take projects offline as well as canceling new pipeline projects, seen most recently with the further delays put on the Keystone XL pipeline proposed to run between Canada and the United States.

If demand remains constant but supply begins to drop, prices will then begin to rise, and after some time delay, the currently stalled projects from the Oil producers will again become economical, they will be put back to work, supply will eventually rise again and assuming demand stays the same prices will level out and begin to become less volatile.

The fracking story has only but helped suppress prices in the short term, as analysts try to predict how much fracking will affect future supply in the oil market. Fracking is an alternative method of extracting oil from deep within rock formations that would other wise be extremely costly to drill. It has only been sustained high oil prices and a break through in new drilling technologies that has allowed fracking to take place on the scale it currently is.

An argument has always existed that Oil prices can, over a 10-20 year period, only increase, particularly as there is only a finite amount of oil in existence.

From an investment stand point, for those able to take a 1-2 year view, oil is at sub $50 per barrel, not only an attractive investment but one of a handful of assets that has the real ability to see 100% appreciation in price over time.

The value for investors looking at the oil markets today is in long dated options in the $75-$85 range going out to 2017. Options give investors the right but not the obligation to purchase a security as a predetermined price in the future.

Asset price performance 3 months 1 year 5 years
WTI Oil -36% -49% -31%
BP +1% -5.3% -23.5%
Exxonmobil -7.4% -2.8% +39%
AP Moeller-Maersk -1.3% +11.8% +61.4%
Transocean -42% -60% -80%

Value also lies in those companies who are providing essential services to the Oil and Gas exploration sector such as tanker and shipping businesses like AP Moeller-Maersk (MAERSK-A:CPH) and Transocean ltd (RIG:NYSE) a provider of contract drilling services.

Looking at Oil producers specifically, companies like BP would be near the top of any investor’s list, still until recently plagued by memories of its Horizon rig disaster and a definitive settlement still unknown opportunity lies within such large cap dividend paying names.

In conclusion although some short-term weakness could see oil down to low $40 per barrel range, this would in many investors opinion create further buying opportunity, the risk averse investor should focus on blue chip dividend paying oil producers, those with the appetite for risk could look at mid to long dated out the money options with a strike price within 50% of where oil trades today at 48$.

Country Break even price (USD $)*
Libya 184
Algeria 130
Iran 130
Nigeria 122
Venezuela 117
Saudi Arabia 106
Iraq 100
Russia 98
USA 80
UAE 77
Qatar 60
Kuwait 54
Norway 40

*prices from IMF Regional Economic outlook – October 2014

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