Oil price and share market behaviour

[SirRumpole]

Can someone explain why the share market has slumped in response to lower oil prices ?

Apart from a few oil companies, I would have thought that everyone else would be delighted.

 

[qldfrog]

Re: Share Market behaviour- Oil price

Can someone explain why the share market has slumped in response to lower oil prices ?

Apart from a few oil companies, I would have thought that everyone else would be delighted.

except for the billions invested in fracking wells by US banks which is going in smoke, and here think loans for the ports/gas trains, etc

 

[Smurf1976]

There's also the "why" factor.

Total world oil production has risen only slightly over the past 12 months, about 1.3%. That's growth, but it's not exactly a boom at the global level.

The real story is about demand growth, or rather the lack of growth, and that says rather a lot about the state of the world economy given that oil consumption is heavily tied to real (non-money shuffling) economic output.

There's also a point about future growth. USD50 oil is starting to kill new exploration and in due course will kill development, thus cutting off the growth in production. Meanwhile we've only got a surplus that's a bit over 2% of world consumption.

So I suspect the share market is pricing in a few realities there. The situation facing oil producers and their lenders is one. That we're effectively limited to a one-off 2% growth in output before running into the oil constraint once again is another. 2% growth is still growth, but as a one-off event it's not a lot when you consider that many economists see 3 - 4% every year as some sort of target.

The situation I see, is one of a wedge if charted. Production costs of the marginal barrel are going up (few if any would dispute that), consumer's ability and/or willingness to pay for that marginal barrel seems to be going down (a theory - not proven but seems quite plausible). The economy is limping along even with cheap oil, so I'm not at all convinced that we could achieve any sort of real growth if oil was back well over $100.

There's the wedge - cost of production going up, ability to pay whilst maintaining consumption seems to be flat at best, quite likely falling. In due course the two lines meet and that's when the real fireworks begin. What happens is uncertain, but something gives at that point it seems fairly certain. If we can't either drop production costs at that point and/or pay more, well then we get a peak in physical production.

Note that the definition of "oil" that I'm using is total liquid hydrocarbons - crude oil, condensate, natural gas liquids (butane etc) and synthetic crude from tar sands, gas to liquids etc. That is, everything that can be used in the way that oil is used to produce fuel etc. If you just took actual crude oil as such, well then the situation is even worse since a lot of the growth has been with the unconventional sources as a by-product of natural gas extraction or as a stand alone activity (most notably tar sands in Canada).

 

[waterbottle]

Re: Share Market behaviour- Oil price

except for the billions invested in fracking wells by US banks which is going in smoke, and here think loans for the ports/gas trains, etc

How many billions are we talking about here?

 

[Julia]

Can someone explain why the share market has slumped in response to lower oil prices ?

Rumpole this link goes to several discussions with Satyajit Das whom I've found to be very accurate and knowledgeable in his comments.
https://www.google.com.au/search?q=...&oe=utf-8&gws_rd=cr&ei=Jc2rVOqHI4r_8QWb8oGIBw

 

[Julia]

Rumpole, this might also help:
http://www.theaustralian.com.au/bus...pping-oil-prices/story-e6frg9df-1227173059806

 

[SirRumpole]

Thanks Julia, Ill check them out.

 

[Value Collector]

The real story is about demand growth, or rather the lack of growth, and that says rather a lot about the state of the world economy given that oil consumption is heavily tied to real (non-money shuffling) economic output.

I agree, oil demand is a gauge of economic activity, But total oil demand has actually grown in the last 12months, it just hasn't grown as fast as supply.

Another key factor is how we use the oil, everywhere you look in the last few years there has been big efforts to use less or substitute. So I think a static oil demand doesn't really mean a static economy, because increases in efficiency mean more products and services can be supplied by each barrel.

For example, a static demand for Gasoline in the USA, doesn't mean a static number of miles being driven, because all of the following mean more miles are being driven on the same litres of oil.

1. more efficent engines and drive chains
2. smaller cars
3. increase usage of hybrids and electric cars
4. increase in cars powered by natural gas
5. Gas to liquid technology substituting some conventional diesel
   

And it doesn't stop there, every where you look in the last few years focus has been on reducing oil usage, eg airlines buying more efficient jet engines, US homes switching to natural gas from heating oil, mining companies switching to natural gas from diesel generators, trucks and trains switching to lng, Gas to liquid plants coming online.

So the total number of services has probably grown faster than the oil demand would suggest.

 

[Value Collector]

Apart from a few oil companies, I would have thought that everyone else would be delighted.

Cheaper energy is a net plus for the global economy, but there will be winners and losers. In general I think it is a net plus for my portfolio.

My only exposure to Oil and gas is through BHP, their petroleum portfolio will be less profitable at current prices, But they are a big oil consumer too, so some of this will be offset by cheaper diesel used to run their Iron ore, coal and copper businesses.

Most of the other companies in my portfolio will benefit from cheaper oil, think of a company like the Walt Disney company, The American public will now on average have more cash in their account each week, there is a good chance this extra cash will be spent on leisure and entertainment, whether that be a trip to the movies, buying the kids a few extra toys this Christmas or birthday, maybe even a trip to Disneyland, or even just downloading a few movies to keep the kids happy.

 

[Toyota Lexcen]

the cheaper fuel we see as consumer may just negate the price rises we are going to see with the lower AUS$ i believe

a few items I have been looking at to buy(from Aus shop) have jumped quite a bit recently,

 

[Value Collector]

the cheaper fuel we see as consumer may just negate the price rises we are going to see with the lower AUS$ i believe

,

and if that were the only benefit, then it would still be a positive, its better to have lower oil prices when the dollar goes down, than higher oil prices.

But look, more energy (in all it's forms) being produced inside an economy is a giant plus, larger quantities and Cheaper energy is good, it means we can produce more stuff and ship it around.

But I don't think cheaper prices will stick around, at current oil price levels, less new wells will be drilled, and the existing wells will naturally decline and bring about a balance again, I don't know at what price, but shale and the other alternatives are produced at between $40 - $65 a barrel, So there will be a natural floor some where in that range, In my opinion it would be towards the top of that range, as wells decline I can't see enough new ones being drilled to maintain supply if the price is below $60.

The low price can stick around in the shorterm term, because the companies have already locked in capital in the current wells and drilling programs etc, but as the drilling programs are wound back, natural decline will see a floor appear, before fresh capital is injected to maintain the supply.

 

[SirRumpole]

Most of the other companies in my portfolio will benefit from cheaper oil, think of a company like the Walt Disney company, The American public will now on average have more cash in their account each week, there is a good chance this extra cash will be spent on leisure and entertainment, whether that be a trip to the movies, buying the kids a few extra toys this Christmas or birthday, maybe even a trip to Disneyland, or even just downloading a few movies to keep the kids happy.

That's what I thought, ie it would have a net positive effect on the market, but that doesn't seem to be the case.

Would it be that the massive wealth of the oil rich nations will decline, making them less likely to invest abroad and therefore drying up the money supply ?

It's doubtful whether this shortage would be made up by local consumers I would guess.

 

[Value Collector]

That's what I thought, ie it would have a net positive effect on the market, but that doesn't seem to be the case.

Would it be that the massive wealth of the oil rich nations will decline, making them less likely to invest abroad and therefore drying up the money supply ?

It's doubtful whether this shortage would be made up by local consumers I would guess.

Instead of exporting the funds overseas to the oil producers, and hoping the funds get reinvested in some way back into our economy, the funds will stay in our economy, inside a broad cross section of australian businesses ready to be distributed or invested.

Eg, lower oil prices means every farmer, miner, trucker, taxi driver, Coles and woolworths, manufacturer, local council, household etc etc, will all have more cash sitting on their balance sheet, inside our economy, thats a better outcome than sending it offshore and hoping it makes its way back through foreign ownership.

The current market reaction is just an over reaction based on shock and uncertainty, thats all.

 

[Value Collector]

In regards to the US economy, every 1cent drop in the price of petrel, adds $1billion dollars into the economy each year. That a big stimulus package right there.

 

[jbocker]

the cheaper fuel we see as consumer may just negate the price rises we are going to see with the lower AUS$ i believe

a few items I have been looking at to buy(from Aus shop) have jumped quite a bit recently,

Will be interesting to see the effect on Aussie stocks that export and stocks that pay dividends in US $.

 

[sydbod]

Currently, the only economy that is doing well happens to be that of the USA.
The growth in employment as well as disposable income happened mainly in the American shale oil industry.
That industry will now slowly get crushed.
Expect unemployment in America to increase. Expect spending in America to decrease or at least wind back.
Expect the American economy to start to contract or stagnate. No more USA as the current growth engine for the world in the near future.

Is it any wonder that global company growth will in all probability start to wind back.

"We DOOMED I TELLS YA!!!!!!!! DOOMED"

 

[Value Collector]

Currently, the only economy that is doing well happens to be that of the USA.
The growth in employment as well as disposable income happened mainly in the American shale oil industry.
That industry will now slowly get crushed.
Expect unemployment in America to increase. Expect spending in America to decrease or at least wind back.
Expect the American economy to start to contract or stagnate. No more USA as the current growth engine for the world in the near future.

Is it any wonder that global company growth will in all probability start to wind back.

"We DOOMED I TELLS YA!!!!!!!! DOOMED"

The low oil price is a big stimulus to the USA economy, it will mean broad stimulus across the nation, even the parts that have been missing out on the shale jobs.

Shale oil wells produce most of their oil in the first 12- 18 months, the production rate drops off very fast, So as I said above, any slow down in the rate of drilling will see production drop off, which will then stimulate more drilling, you have to be drilling continuously to maintain production.

What we will probably see is a slow down in the rate of drilling, Most of the cost of shale oil is in the initial drilling costs and completing the well which can be expensive when you're in a rush to complete as many wells as you can. So drilling won't stop, it will just slow down, as companies focus on completing each well as cheaply as possible.

a slow down in drilling will naturally see a slow down in production as existing fields decline, which will support prices again and then an increase in drilling again. that's why it's called cyclical.

Its actually a good thing, remember in 2008 we were all worried about peak oil, at least for now the oil supply is only limited by the price the market wants to pay and the speed we can drill shale beds.

 

[qldfrog]

Re: Share Market behaviour- Oil price

How many billions are we talking about here?

did not forget your answer.
I can not find the reference again
I also seriously doubt every decrease in petrol cost is that beneficial anymore in the US.
Things are very different today from the same situation 10 years ago
it can not when you move from energy importer to exporter.
will keep looking for the figures regarding investment in sjhale oil by US banks

 

[waterbottle]

Re: Share Market behaviour- Oil price

did not forget your answer.
I can not find the reference again
I also seriously doubt every decrease in petrol cost is that beneficial anymore in the US.
Things are very different today from the same situation 10 years ago
it can not when you move from energy importer to exporter.
will keep looking for the figures regarding investment in sjhale oil by US banks

I found this article on zerohedge. The article itself cites the wall street journal as its source:

American oil and gas companies have gone heavily into debt during the energy boom, increasing their borrowings by 55% since 2010, to almost $200 billion.

Their need to service that debt helps explain why U.S. producers plan to continue pumping oil even as crude trades for less than $50 a barrel, down 55% since last June.

But signs of strain are building in the oil patch, where revenue growth hasn’t kept pace with borrowing. On Sunday, a private company that drills in Texas, WBH Energy LP, and its partners, filed for bankruptcy protection, saying a lender refused to advance more money and citing debt of between $10 million and $50 million. Neither the Austin-based company nor its lawyers responded to requests for comment.



Energy analysts warn defaults could be coming. “The group is not positioned for this downturn,” said Daniel Katzenberg, an analyst at Robert W. Baird & Co. “There are too many ugly balance sheets.”

In 2010, U.S. companies focused on producing oil and gas had $128 billion in combined total debt, according to financial data collected by S&P Capital IQ.

As of their latest quarter, such companies had $199 billion of combined total debt.

Before crude prices began falling, U.S. oil and gas producers were able to acquire leases and drill wells even if that meant outspending their incomes. Debt was used to bridge the cash shortfall so that companies could develop oil fields in Texas, North Dakota and newer locations including Colorado.

So according to this the debt owed by the companies and therefore held by the banks amounts to $199 billion. That figure doesn't seem that big compared to the subprime crisis that triggered the GFC.

 

[Value Collector]

Re: Share Market behaviour- Oil price

So according to this the debt owed by the companies and therefore held by the banks amounts to $199 billion. That figure doesn't seem that big compared to the subprime crisis that triggered the GFC.

Also remember, when a shale company has a production cost of say $50 a barrel, The majority of that cost is related to the original cost of drilling the well being amortised, very little of the production cost relates to pumping the oil once the well has been completed.

So these wells would still continue pumping oil even if the price was $30 a barrel, and that $30 a barrel cash flow would be going back to pay off the debt, sure the company is not going to make any profit and will lose the equity they injected into the deal and may go bust, But if the bank had funded say 50% of the cost of the wells, they should be able to get most of that back even when the price is well below the on paper cost of production.

what I am trying to say, is that just because the oil price drops below the cost of production, doesn't mean there is no cash flow to repay debt, the cash will keep coming in and servicing debt.