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Mayhem in the Oil Industry - the Future is Gas !

This week my 11 year old son took part in an Energy Summit at his school in Singapore, wherein each pupil had to advocate their chosen fuel for the world. Not one of the kids advocated oil or coal, almost all were backing nuclear power – and my son was the only one lobbying for natural gas. For an 11 year old the Fukushima nuclear accident was in a previous era while the pollution and pricing problems with fossil fuels are on Google News every day.
The sharp decline in oil prices over the past year has caused mayhem in the oil industry. Over the long term it should be seen as beneficial, not just as the transfer of wealth to consumers from producers’ profits and government taxes: the shake-out removes inefficiencies in the industry and allows transformational developments such as the removal of fuel subsidies in Indonesia and India. The action of Saudi Arabia to maintain production, despite a massive revenue hit, indicates that “peak oil” is a long way off – if Saudi Arabia believed that its oil reserves are close to a limit then it would try to maximize the value today, even though this would hasten developments of alternative fuels. No, the signal is that Saudi has oil for generations to come, so the oil price should stay lower than in recent years, at least below $100/bbl.

 
There are many unintended consequences of the oil price decline, some of which have yet to come to pass. The collapse in valuations for upstream companies and redundancies in the services industry are plain to see; the falls in the value of the Russian Ruble and the Norwegian Krone were predictable, and we are seeing some esoteric effects such as the first deflation in living memory in UK. But other consequences are less predictable and reflect the complexity of the interactions between the oil industry and the global economy.
 
Oil traders finally reaped profits in late 2014 from the increase in oil price volatility after years of subdued volatility, but the lower oil price, increasing transparency, cut-throat competition and funding limitations will still make 2015 a tough year for many oil traders. In previous oil price declines we saw an upturn in oil refining margins, but this time the effect is muted and refining continues to be, at best, only marginally attractive in most parts of the world (except for US hydroskimmer refineries who are processing shale oil). After the last oil price collapse I had to announce to shareholders that a major portion of the 2008 profits for our listed Chinese company had been wiped out - by the collapse in the year-end value of jet fuel inventory in our airport terminals. No doubt other companies with significant inventory will see a similar fate this year.
 
The true impact of the low oil price in the financial markets has yet to be seen. I imagine significant problems will arise as upstream and service companies soon announce year-end results that could break bank covenants, cause repayment defaults and force asset sales. However the current lack of certainty in future oil prices means that forward planning for investments or acquisitions is difficult - the bid-offer spread between buyer and seller for oil assets is now so wide that it may only be in late 2015 that M&A deals really materialise and the mess gets sorted out. There is a hiatus – everyone wants to wait and see, no-one wants to make a decision !