Credit: Peter Gronemann/Wikipedia

Will the oil price hurt BAE Systems?

The aerospace firm benefits from instability in the Middle East, but cheap oil means defence budgets are tight.

by Adam Gale
Last Updated: 18 Feb 2016

War. What is it good for? Absolutely nothing. Who is it good for? Defence contractors, obviously. Sales at BAE systems rose 7.6% to £17.9bn in 2015 as the Syrian conflict escalated. Orders from the UK and Saudi Arabia both increased, but the latter still refused to make a big order of Typhoon fighters, despite last doing so way back in 2012.  

BAE announced a few months ago that it would slow production of the fighter jet as a result, which is largely why underlying earnings before interest, tax and amortisation fell 1.1% to £1,683m. Chief executive Ian King is pinning his hopes on a new order from the Gulf kingdom, saying ‘talks are always ongoing, because we have a relationship which is ongoing.’

But Saudi Arabia has some a few cash flow problems right now. Its budget has been gutted by the sustained fall in the oil price, from $110 (£76) a barrel in mid-2014 to lows of $28 last month. The kingdom is currently running a deficit equivalent to 15% of GDP, which has led it to consider selling a stake in the mother of all cash cows, state oil giant Aramco. Hardly an ideal time to splash out on several hundred state-of-the-art jets.

Without an escalation in the ongoing Middle East crisis, it doesn’t seem to bode well for BAE. But there are signs of hope. The Saudis and the Russians made a tentative agreement not to increase crude production in an effort to let the price recover, and in a surprise twist the Iranians said they supported the move.

The price recovered to $35 on the news. It may be a very long time before it’s back at $100 though, as Iran’s four-million barrel a day industry won’t stay dormant forever, deal or no deal. Given the implications this has on the Saudi defence budget, BAE has been diversifying. It invested heavily in cyber security division last year, and revenues in that section duly rose 31%. While it still represents well under 10% of the overall business, in a cheap oil world it’s a smart move.    

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