How U.S. Steel Would Benefit From A Recovery In Oil Prices

The recent decline in oil prices has taken its toll on U.S. Steel (NYSE:X). The company announced plans to idle two plants producing tubular steels earlier on in January. ^[1] These plants are a part of the company’s Tubular Products division, which produces seamless and electric resistance welded (ERW) steel casing and tubing (commonly known as oil country tubular goods or OCTGs), standard and line pipe, and mechanical tubing. These products are sold to customers in the North American oil, gas, and petrochemical sectors. Due to the sharp decline in oil prices, which stood roughly 60% lower in January from the levels seen in the middle of last year, there has been a sharp reduction in upstream capital expenditure by oil companies in North America. ^[2] This has dampened the demand for OCTGs produced by the Tubular Products division and has forced the company to idle some of its production capacity.

Crude oil prices have declined due to weak demand and an oversupply situation. Demand for oil remains weak in the midst of economic weakness in Europe and slowing Chinese growth. China, the world’s second largest importer of oil, is expected to witness a slowdown in GDP growth to 6.8% and 6.4% in 2015 and 2016 respectively, from 7.4% in 2013. ^[3] 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. ^[4] With a weak demand situation compounding a supply glut, oil prices have declined sharply.

Oil prices have recovered marginally from their levels in January. We expect oil prices to increase gradually over the next couple of years, as global demand recovers and capital expenditure cutbacks from producers result in the tightening of supply. However, there is a possibility of a sharper V-shaped recovery in prices, if demand grows faster in response to lower prices, or if OPEC alters its stance and reduces production in response to low prices. Such a scenario will boost the prospects of U.S. Steel’s Tubular Products division. In this article, we will explore the impact of a V-shaped recovery in oil prices on the company.

See our complete analysis for U.S. Steel

Impact of V-shaped Recovery in Oil Prices on U.S. Steel

In the event of a faster than expected recovery in global economic growth, demand will recover sharply in response to low oil prices. This will provide a boost to global oil prices. Though oil prices are not likely to exceed $100 per barrel even in the high demand recovery scenario if OPEC does not cut back on production, there could be a significant increase in U.S. oil and gas production even at lower levels. Around 98% of crude oil and gas production from the U.S. has a break-even price of below $80 per barrel. ^[5] If prices exceed $80 per barrel for sustained periods of time by 2016, there could be a significant increase in U.S. oil and gas production and demand for OCTGs. Such a scenario is likely to result in a significant increase in the shipments of the Tubular Products division, as the company restarts idled tubular steel production capacity in response to improved market conditions. Such an outcome would also positively impact realized prices for the division and the combination of higher volumes and pricing would boost the division’s margins.

If we factor in the impact of a V-shaped recovery in oil prices on the drivers for the Tubular Steel division in our earnings  estimate for U.S. Steel, it boosts the company’s earnings per share by around 40%.  While the Tubular Steel division as a whole contributes only around 10-12% of US Steel’s revenues. this sharp increase may convince investors that prospects are improving at the company, and an upward adjustment in valuation could potentially follow.

See our complete analysis for U.S. Steel in the scenario of a V-shaped recovery in oil prices

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1. U.S. Steel Lays Off 756, Blaming Low Oil Prices, Wall Street Journal [↩]
2. WTI Crude Oil Spot Prices, Y Charts [↩]
3. World Economic Outlook, IMF [↩]
4. Global Oil Glut Sends Prices Plunging, Wall Street Journal [↩]
5. Low oil prices to bite into 2015 U.S. shale growth: IEA, CNBC [↩]