Crude Oil: A Quick Recap Of The Year 2015

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The year 2015 has been extremely tough for everyone who has been betting high on commodities, particularly crude oil and natural gas. Crude oil and natural gas prices, which began to plunge in mid-2014, continued to fall drastically during the year, making it difficult for the big players in the oil and gas industry to remain afloat. The two global benchmarks for crude oil – WTI and Brent – dropped by almost 30% since the beginning of the year, while natural gas was down by more than 40% during the same period. In this note, we take a quick look at the key events during the year that pushed oil and gas prices to multi-year lows and discuss what 2016 may have in store for these commodities and related industries.

O&G prices

Source: US Energy Information Administration (EIA)

Demand-Supply Mismatch Prevailed

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The sudden drop in oil prices over the last few quarters has been driven by the disturbance in the demand and supply factors in the global markets. Over the last year and a half, the demand for oil declined significantly as China, one of the largest importers of oil, shifted to a less-energy intensive model of economic growth. This, coupled with the weakness in the Latin American market, particularly Brazil, further reduced the oil demand. On the other hand, the supply of oil continued to increase many-fold, due to the shale oil boom in the North American region and the continued production by the Organization of Petroleum Exporting Countries (OPEC). In the absence of adequate demand, the over-saturated oil markets led to a steep rise in the oil inventories, leading to a drastic fall in the oil prices globally. As has been the case in the past, the industry players looked to OPEC for a cut in its oil production to prevent the oil prices from falling further. However, in June, the cartel decided to continue to produce oil at a high rate to sustain its market leadership position. As a result, the oil markets continued to remain oversupplied, causing the oil prices to average  around $50 per barrel for the full year 2015, as opposed to close to an average of $100 per barrel the previous year.

OPEC Will Continue Pumping Oil

In August of this last year, data released by the Chinese authorities created a fear of a potential slowdown in the world’s second largest economy, which sent a wave of panic among the investors across the globe. This not only wiped out the little recovery that took place in the oil prices, but forced the oil prices to trade below $40 per barrel. While this led to a massive stock sell-off in the global markets, the industry experts believed that the commodity (oil) had bottomed out and predicted a recovery by early 2016. The market expected a reversal in OPEC’s stance of pumping high levels of oil at its December meeting. However, contrary to this, the cartel decided to defend its market share and continue to produce at its record high levels of 30-31 million barrels of oil per day. This means that the cartel will not have an official production target, at least until its next meeting in June 2016. Keeping this in mind, we believe that the oil prices will not be expected to rebound at least until the second half of 2016.  Since this would mean lower price realizations for oil and gas companies such as ConocoPhillips, Anadarko Petroleum, and Chesapeake Energy, we expect to see a further deterioration in their earnings over the next few quarters.

See Our Complete Analysis For ConocoPhillips Here

Lifting Of Iran Sanctions To Add To The Oil Glut

In the past, several countries had imposed sanctions against Iran when the country refused to suspend its nuclear enrichment program. However, during 2015, the US government finally decided to lift the international sanctions imposed on Iran’s oil production, subject to a number of conditions. While this would be in the interest of Iran, it is likely to have severe implications for the oil markets. According to the International Energy Agency (IEA), Iran has the potential to bring up to 3.6 million barrels of oil per day onto the global oil markets within six months of the lifting of these sanctions. Further, the country has an estimated inventory of 30-40 million barrels of oil ready for delivery. So, if this Iranian oil comes into the already over-saturated oil market, it would further pull down the oil prices and delay the oil price recovery to the later half of 2016. Since the Iranian government has reaffirmed that it will not delay its oil production once the sanctions are lifted in early 2016, we forecast that this will force oil and gas companies to restrict their upstream spending throughout 2016. We expect this to result in a drastic decline in the demand for exploration and production in the market, which would highly impact the top line of oilfield services companies, such as Schlumberger, Halliburton, Baker Hughes, and Transocean.

See Our Complete Analysis For Transocean Here

US Lifts 40-year Export Ban

OPEC’s stance to pump oil at a high rate is aimed at forcing US oil and gas producers to either pull back their oil production or exit the market. However, the oil and gas majors have chosen a non-linear path and have lobbied the government into lifting the 40-year export ban on the US oil. With the lifting of this ban, US oil that was restricted within the country will now be available in the global markets, which already have a surplus of oil. Moreover, since this will give the US oil a level-playing ground, the Brent and WTI oil prices are likely to converge. In fact, there is a strong possibility that WTI oil will start trading at a premium to Brent oil in the near future. While this will enable US oil and gas producers to gain higher rates for their oil in a strong oil price environment, it is likely to accentuate the drop in oil prices going forward.

WTI-Brent

Source: US Energy Information Administration (EIA)

Although the depressed oil and gas prices have led a number of US companies into bankruptcy, industries that use crude oil as an input for their operations have hugely benefited from this downfall. For instance, the US airline companies, such as American Airlines, United Continental, and Delta Air Lines, have posted record high profits over the last 4-5 quarters due to fuel cost savings. Given a bleak outlook for oil and gas prices over the next year, we anticipate the airline companies to deliver extraordinary results even in the coming quarters.

See Our Complete Analysis For American Airlines Here

In a nutshell, the year 2015 was a challenging and disappointing year for the oil and gas industry, as a whole. Based on the above mentioned arguments, we do not see a recovery in oil prices at least until the latter half of 2016.

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