Which firms gain from the oil price slump?

Brent crude drops to $76 a barrel ahead of the OPEC conference. That's a good thing, right?

by Adam Gale
Last Updated: 19 Dec 2014

These days, it’s not just the Gulf of Mexico that’s slick with black gold. Since the summer, oil prices have dropped dramatically to $76 (£48) a barrel for Brent crude and $72 for West Texas Intermediate (the American stuff), having been around $110 for most of the last four years. The main reason for this stomach-squeezing drop is the abundance of oil from ‘unconventional means’, otherwise known as fracking.

Fracking has doubled production in the US since 2008, to over nine million barrels a day, flooding the global market. OPEC, the state-level oil cartel that held the world’s economy to ransom in the 70s, isn’t happy. Its share of world production has fallen to 40%, and its ability to control prices has faded.

An oil company chairman's nightmare. After years of stability, crude prices have plunged since the summer.

At its meeting in Vienna today, OPEC will decide the cap on its production, which once controlled the price of oil. Indications coming from the Saudis, who are the ringleaders of the 12-nation group, are that they will not cut production. The market would ‘stabilise itself eventually’, said Saudi Oil Minister Ali al-Naimi.

Low prices hurt OPEC countries because state revenues depend on oil duties, but it’s possible the cartel wants to reassert itself by letting prices tumble. It knows, for instance, that low prices will be much more damaging to producers orchestrating fiendishly complicated, chemically-assisted horizontal drills into American shale fields than those digging holes into Middle Eastern deserts and waiting with buckets ready.

The US Energy Information Service puts the average cost of extraction in the Middle East at a measly $20, while a recent estimate by Maria van der Hoeven, executive director of the International Energy Agency, said that 18% of crude oil produced in America had a break even price of over $60.

Low oil prices may well be a temporary thing, given the world’s growing addiction to the stuff and the fact that resources remain fundamentally limited, but who’s it going to help in the meantime, and who’s it going to hinder?

The Losers

Shackle yourselves to your seats and prepare to be amazed. The biggest losers will be... oil companies. This might seem like the biggest no brainer since zombie Incredible Hulk (if that hasn’t happened already, it should), but there are oil companies and there are oil companies.

The big beasts like BP and Shell have diverse enough supply portfolios to survive price dips, particularly in the short term. The ones who could really suffer from low prices are the more recent entrants into the US fracking market. Unlike the early movers, these firms paid fortunes both for drilling rights and for the wells themselves, the more easily reached shale oil already having been slurped up.

To make matters worse, many of these investments will have been made when oil prices were high, leaving these firms with uncomfortable levels of debt. This debt is now much higher risk than it once was, which itself puts pressure on the banks who lent it in the first place. Energy debt has risen from 4% to 16% of America’s $1.3tn junk bond market in the last ten years, and the FT reported banks including Barclay’s face heavy losses on an $850m loan to oil firms.

Governments aren’t going to be happy either, in the short term. Aside from states like Saudi Arabia and Venezuela, which depend on oil revenue, countries like Britain also take a decent chunk of what is presently a rapidly diminishing pie. The Treasury could miss out on billions if the price stays low.

The Winners

Unless you’re a government, an oil company or a bank that’s lent to an oil company, this is probably good news. Lower fuel costs increase consumers disposable income and reduce transport costs, both of which are manna from heaven for most businesses.

Some sectors will benefit more than others, of course. Airlines and haulage firms’ bottom lines both depend on the cost of fuel, and ancillary service and supply businesses will also gain. Low oil prices will also take the load off heavy manufacturing and automotive companies, which have high transport costs both for raw materials and for the finished product.

It’s also good news for bulk chemical firms, for which oil is again the principle marginal cost. The news might be a mixed blessing for Ineos, however, which recently bought certain fracking rights near its Grangemouth facility. Cheap oil is clearly good for Jim Ratcliffe’s firm, but those rights may seem increasingly overpriced or even unnecessary as the oil price continues to go down.

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