February 9, 2016    5 minute read

The Oil Price Slump Uncovered

   February 9, 2016    5 minute read

The Oil Price Slump Uncovered

The black gold, commonly so called, may be crowned as the commodity of the year. The fourth quarter of 2015 will be marked up as one of the most painful in recent memory for the oil and gas industry. The crude oil price collapse began in July 2014 and had kept on doing so until the first months of 2016.

Crude Oil

Several reasons may explain the fall. For instance consistently low-interest rates settled by central banks have partially diverged investor expectations, moving capital flows into the development and over-production of marginally profitable unconventional oil with high coupon yields compared with other investments. However, this increasing supply has not been matched by an equivalent growth in demand. Also, since the US has become a major oil producer, their huge economy ceased to import the crude oil from OPEC, determining a sharp demand slump and consequently over the price of it.

The resultant of a market strictly driven by speculation, where the excess of supply is far and away greater than demand, translated into some pretty ugly financials for the biggest companies in this sector.

Exxon Mobil, for instance, during the fourth quarter of 2015 registered a significant drop in its profits by 58%, marking so the oil giant’s smallest profit since the third quarter of 2002. While profits of the downstream sectors made a significant jump ahead, almost tripling the incomes from USD$497 million to USD$1.35 billion, the upstream sector plummet in the red zone. The overall bad performance of the sector, led by bad results from the major companies, had as its natural consequence a notable plummet of the major stock indexes as we can see from the graph below.

Source: Bloomberg

(Source: Bloomberg)

Now, the natural question that arises is if a low crude oil price is a good or bad thing. From a microeconomic point of view, low oil price means several unfortunate consequences. For instance, the major oil companies, are certainly not pushed to make new investments to extract oil in new sites, more efficiently and ecologically. This lack of investments, along with the policy of losses stem, often carried out with “justified dismissals”, end up with fewer profits and unemployment.

As far as the macroeconomic side is concerned, we can observe that several economies around the world are strictly tied to the crude-price dynamics. Let’s consider for instance the Russian economy. The low oil price has profoundly impacted over the Russian annual deficit, increasing consequently the debt and shrinking the annual GDP, which has followed the same path of the oil price as the following graphs show.

Source: Bloomberg

(Source: Bloomberg)

 

Source: Bloomberg

(Source: Bloomberg)

Russia Government Budget 

From an investor standpoint, the downward trend of the crude oil price should have brought benefits, but empirically speaking, has not done so.

Although the oil industry often represents a significant slice of the cake made by all the industries on the major stock exchanges, it is not the main one. The low oil price that we can observe should theoretically bring more profits for all of the manufacturing companies, due to the small cost of production. A cut of costs is often coupled with more offer, backed by an increasing demand due to the more savings that families have for consumption, thanks always to the low oil price. Furthermore, a low oil price should also bring some benefit to those who invested in fixed-income bonds. Indeed, a low oil price should line up with a low inflation rate and low-interest rate.

Nevertheless, looking at the empirical data, we can observe an opposite trend. For instance, if we consider some of the most important composite indexes, we can see that in an extremely volatile scenario, results are rather low. However, we should bear in mind that several geopolitical conditions are affecting such performances, as well as non-excellent macroeconomic data of various countries throughout the old continent, as well as overseas.

Source: Yahoo Finance

(Source: Yahoo Finance)

A couple of months ago, several analysts claimed that the low crude oil price was among the most important contributions for  economic growth. Nowadays, they claim that is one of the main reasons for the slow down of the economy. Some analysts even claimed an upcoming “year of cataclysms”: deflation crisis, despite the efforts made by central banks in order to avoid it, principal composite indexes that will lose over 1/5 of their current value and a drift of crude oil price to US$10 per barrel.

The truth, apparently, it is not given until we know it, but what if the market, considered as a pool of investors, decides one day that it is the right time to slump. The reasons for every crisis have always been explained ex post, never ex ante and every recent crisis begun from the market: what if the market is the cause and not the effect?

Get articles like this straight to your inbox each morning with our Breakfast Briefing. Sign up by clicking here!

Log in with your details

or    

Forgot your details?

Create Account

Send this to a friend