Why Weak Oil Prices Could Negatively Impact U.S. Steel

Crude oil prices have recently witnessed a significant decline from their peak values this year. West Texas Intermediate (WTI) crude oil spot prices currently stand at levels of around $78 per barrel, around 28% lower as compared to their values in June this year. ^[1] The current environment of low oil prices has raised concerns about the sustainability of the roust growth in oil and gas production in the U.S. The rate of oil and gas production in the U.S. has a direct impact upon the fortunes of U.S. Steel’s (NYSE:X) Tubular Products division. The Tubular Products division produces and sells seamless and electric resistance welded (ERW) steel casing and tubing (commonly known as oil country tubular goods or OCTG), standard and line pipe, and mechanical tubing. These goods are primarily sold to customers in the oil, gas and petrochemical markets, the production facilities for which are located mainly in the U.S. ^[2] In this article we will take a look at the ramifications of the prevailing subdued oil pricing environment on U.S. Steel.

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Oil Prices

Crude oil prices have declined recently due to an oversupply situation. Global oil supply has been boosted by rising oil and gas production from the U.S., where hydraulic fracturing techniques have helped boost output. In addition, major oil producers of the Organization of the Petroleum Exporting Countries (OPEC) have not lowered output in response to falling prices, in order to preserve their market shares. ^[3] Demand for oil remains weak in the midst of economic weakness in Europe and slowing Chinese growth. China, the world’s largest importer of oil, is expected to witness a slowdown in GDP growth to 7.3% and 7.1% in 2014 and 2015 respectively, from 7.7% in 2013. ^[4] With a weak demand situation compounding a supply glut, oil prices will remain subdued in the near term. This may hamper the growth in oil and gas production in the U.S.

Impact on U.S. Oil and Gas Production

Small and mid-size oil and gas companies have played a major role in the recent surge in oil and gas production. A significant proportion of  these companies had taken on large amounts of debt in order to fund their drilling programs. ^[5] While global oil majors may still be able to operate profitably at the current level of oil prices, indebted small and mid-size companies may find it harder to operate, particularly if oil prices fall further.

As per statements from the International Energy Agency (IEA), around 98% of crude oil and gas production from the U.S. has a breakeven price of below $80 per barrel and 82% has a breakeven price of $60 per barrel or lower. ^[6] Though the current level of oil prices may not result in a significant drop in production levels, it will certainly have an impact upon new projects being undertaken. As per IEA estimates, there could be a 10% reduction in upstream capital expenditure in the U.S., if current levels of oil prices prevail. ^[6] This could negatively impact the fortunes of U.S. Steel’s Tubular Products segment.

Impact on U.S. Steel

The Tubular Products segment was a fairly profitable business for U.S. Steel. Gross margins for the division stood at 15% in 2012, as compared to 8% for the company’s other business segments that year. ^[2] However, margins for the segment fell to 11% in 2013, as the company faced competition from cheap OCTG imports. ^[2] With the U.S. International Trade Commission (ITC) ruling that anti-dumping duties will be levied against a majority of these imported OCTGs, the competition from OCTG imports is likely to dissipate. ^[7]

The Tubular Products division can once again potentially become the company’s most profitable division, provided that the robust demand for OCTGs persists. However, this may not be the case, given that upstream capital expenditures are expected to drop by 10% in 2015. A fall in demand for OCTGs could result in a fall in both shipment volumes and realized prices for the Tubular Products division. The exact impact upon shipments, realized prices and consequently, margins remains to be seen. However, the weak oil pricing environment is clearly a threat to the fortunes of the Tubular Products division. If the expected reduction in oil and gas drilling activity materializes, the company will have to rely upon its other business segments to drive results.

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1. WTI Crude Oil Spot Prices, Y Charts [↩]
2. U.S. Steel’s 2013 10-K, SEC [↩] [↩] [↩]
3. Global Oil Glut Sends Prices Plunging, Wall Street Journal [↩]
4. Goldman Sachs cuts China growth forecast sharply, Market Watch [↩]
5. Energy Boom Can Withstand Steeper Oil-Price Drop, Wall Street Journal [↩]
6. Low oil prices to bite into 2015 U.S. shale growth: IEA, CNBC [↩] [↩]
7. U.S. steel pipe makers win key anti-dumping case against cheap imports, Reuters [↩]