In theory, and it is a theory backed by some high-powered research, shares in Australian oil and gas companies such as Woodside Petroleum and Santos have much further to fall, a fact which prompts a question: why haven’t they already fallen further?
In theory, and it is a theory backed by some high-powered research, shares in Australian oil and gas companies such as Woodside Petroleum and Santos have much further to fall, a fact which prompts a question: why haven’t they already fallen further?
The answer is that many, perhaps most investors in the oil and gas industry are looking beyond today’s $US50 a barrel oil price to a time when normality returns.
The problem with that optimistic view is that normality could take some time to return, and before that share prices could go much lower, and then there’s the question of what will be the new normal because oil seems unlikely to quickly return to $US100/bbl.
Woodside, according to analysts at the investment bank, Credit Suisse, could potentially fall to $18.74, roughly half today’s price of around $36, while Santos could fall to 13c, a fraction of today’s $7.34.
Largely ignored by investors when it was published on Tuesday the Credit Suisse view of the Australian energy sector makes for sobering reading, and while it is an extreme view it does provide a guide to what might happen if the current flood of oil persists and the current oil price and U.S. dollar exchange rate is maintained in perpetuity.
No-one believes those assumptions, least of all the Credit Suisse research team, because not much moves faster in the financial world than the oil price, except exchange rates, and oil floods in the past have always dissipated when the price falls.
What appears to be happening is that investors with a six-to-12 month view of the oil market are buying shares in oil companies whereas investors who either need the cash now, or believe that there is a fundamental change underway in the oil market, are selling.
On balance, the correct view is that most of the damage likely to be inflicted on Australian oil companies has been inflicted and while there might be another downward leg if the oil price falls below $US40 a barrel the share prices you see today could well be the new normal.
That does not mean the Australian oil and gas sector will avoid a wild ride over the rest of 2015.
Cash flows will be tight, especially for companies such as Santos which is busy bedding down a new coal-gas based LNG project in Queensland, and planned developments will be further deferred, especially the Browse LNG project of Woodside – no matter what WA Premier, Colin Barnett, might believe.
But, over the next few months as high cost oil is driven out of the market, and demand for oil picks up thanks to the beneficial effects of a low price, it will become possible to identify what the new normal likes like and that seems to be oil at around $US80/bbl.
Critical to what’s happening is that while the oil world is in turmoil the rest of the world is not.
In fact, low oil prices could prove to be a more valuable driver of global economic growth than the low interest rate regime of the past seven years.
The difference between the stimulus of low rates and low oil is that one is the result of government edict and the political interference (and incompetence) implied while the other is a market at work – with all of the brutality and simplicity implied.
Low rates and government stimulus stabilised the global economy but surprisingly little of the extra cash has reached the real economy with business loans in Europe and the U.S. still hard to arrange.
Low oil is having a totally different effect. It is real, immediate, and largely beyond the control of government. Money saved on fuel bills is already hitting the real economy.
The best way to see what’s happening today is to look back at what’s happened in previous periods of excitement in the oil market and marvel at how quickly a glut, or a shortage, is corrected.
The current situation is largely a result of the oil price rising too far which encouraged too much production, exactly like the iron ore industry.
Lower prices are having the reverse effect with one important difference. The oil market will adjust much faster than the iron ore market, as has happened in the past.
