Interactive Investor

This oil crash has thrown up some bargains

23rd June 2017 14:23

Neal Underwood from interactive investor

Crude oil prices slid into bear market territory on Tuesday this week, as global oversupply continues to drive prices lower. This was the third drop of around 3% in a fortnight, despite an extension of the deal to cut crude output within both members and non-members of oil cartel OPEC.

On 30 November last year, OPEC agreed an oil production cut of 1.2 million barrels a day to 32.5 million barrels, coupled with promises from various non-OPEC producers to remove a further 0.6 million barrels a day from the market.

While this cut should have been a positive for near-term oil prices, it has failed to materialise as OPEC’s previous tight control over the oil price continues to loosen.

The six-year rally which by 2014 had taken oil to $110 a barrel ended abruptly, as unbridled oil production from OPEC and Russia had created a situation of oversupply just at demand began to falter. By early 2016 the price had collapsed to just $26 a barrel. It’s currently $44.81.

Supply and demand dynamics are key to driving the oil price. In 2015, OPEC member countries were producing almost as much as they liked.

Leading cartel member Saudi Arabia is blamed for the dramatic drop in the oil price over the past couple of years, as it seeks to protect market share against other major producers like the US and Russia.

Flooding the market with oil has created an extended period of low oil prices aimed at taking out higher cost rivals, such as US shale producers, in the hope of forcing these competitors to cut production or cease producing entirely.

At the same time, weak global economic activity post the financial crisis, combined with energy efficiencies and moves towards renewables, have driven demand lower.

Brent Crude oil price over 10 years

So, what next for the oil price? Will it rebound again, or is it doomed to be structurally lower for the foreseeable future?

There have been some major changes within the oil industry, none more so than the advent of horizontal drilling and fracking technology, which allows untapped potential of the world’s vast shale gas reserves to be exploited. US shale production, in particular, has heaped yet further pressure on the oil price.

Norbert Rücker, head of commodities research at Julius Baer, says: “We see oil trending sideways, spending more time in the high 40s than the low 50s, in part because the shale revival and stagnant western world oil demand undermine the Middle East’s restriction efforts.”

He believes the latest tensions in the Gulf region between Saudi Arabia and Qatar, over the latter’s alleged terrorist links, are unlikely to negatively impact energy supplies.

Middle East tensions are always a concern, and there could yet be a spanner in the works in the shape of the appointment of the Saudi King’s 31-year-old son Mohammed bin Salman, nicknamed MbS, to the role of Crown Prince, which makes him heir to the throne of the Kingdom of Saudi Arabia.

His appointment is seen as increasing the likelihood of military conflict between Saudi and Iran. Any geopolitical or military tensions would be highly likely to precipitate a spike in the oil prices.

MbS is also head of the oil ministry and was responsible for crushing the oil price from its 2014 high in an attempt to force out high cost producers. His focus is not on maximising the oil price, but rather on market share. He is keen to maintain both Saudi’s share of global oil revenues and oil’s share of the global energy market.

In addition, he wants to wean Saudi off its dependence on oil; Saudi’s national oil company Aramco's upcoming IPO is part of that plan.

If we do enter a period of structurally lower oil prices, a number of companies could benefit. Interactive Investor’s resident oil guru, Malcolm Graham-Wood, founding Partner of HydroCarbon Capital, recently picked out five for us.

“As the oil price has come down these companies’ costs have been coming down, and they can still be profitable at $20 or $30 a barrel,” he said. “All these companies will be able to take advantage when the oil price has pushed the price of shares down but their underlying intrinsic value is still high.”

  • Amerisur Resources – operates in Colombia and has had flow of good news in last few weeks. Malcolm expects it will return to previous highs
  • Faroe Petroleum – has been doing very well, but quietly of late
  • SDX Energy – has been performing particularly well in Egypt and is developing assets in Morocco
  • Victoria Oil & Gas – the market for the gas its producing in Cameroon is very strong and it has a lot of potential upside
  • Aminex – this company has recently made a big discovery in Tanzania. Malcolm is expecting big things here

Despite all the negative news, the Energy Information Administration (EIA) predicts continued demand for oil will reduce the worldwide glut and usher in higher oil prices in coming years, as can be seen in the table below:

A major factor will be growing industrialisation and the world’s ever-increasing population. The United Nations estimates that the world population will grow from the current 7.5 billion people to 9.7 billion in the year 2050.

This could go some way to increasing the demand for oil, and propping up the oil price, for the foreseeable future.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.