Russia Blames Trump
Oil is shaking off a bearish API report after the U.S. stock market pulls off one of the biggest comebacks in stock market history. This comes one day after the biggest one-day point gain in stock market history in the worst December since 1931 and oil, that was once leading the stock market lower, is now looking to stocks to find direction. Oil had a terrible quarter as did stocks, and if there is anyone to blame the Russians say that it is President Donald Trump.
Reuters reported that Russian Energy Minister, Alexander Novak, said that rising protectionism, and the unpredictability of the Trump Administration, had greatly contributed to global oil price volatility over the past two years. With the risk of me appearing to be colluding with a Russian, I would have to say to some extent, I agree. There is no doubt that Trump’s hard line on Iran raised oil prices inspired Russia, among others, to raise production. Trump then granted waivers to the biggest buyers of Iranian crude, which helped drive down the price and led to a lack of confidence. The uncertainty of trade war, the government shutdown and the strong reaction to the quarter-point interest rate increase and market turmoil have only fed the perception of an oversupplied oil market.
Yet for every major market action, there is an equal and opposite overreaction. OPEC will overreact and cut production led by Saudi Arabia, who needs $85 a barrel to meet its budget. The reality is that as far as the economy goes, things are not that bad. As far as oil demand goes it continues to be strong. As far as the so-called oversupply in oil next year with OPEC and Russian oil cuts, we will most likely be in a supply deficit. Russia’s Novak is saying that they will cut by between 3 million and 5 million tons in the first half of 2019. While Donald Trump failed to live up to his promise of zero oil exports from Iran, the Saudis may send zero exports to the U.S., making it much harder for U.S. refiners that rely on Saudi’s heavy crude.
Oil is looking for signs of falling global demand. Some might have thought they saw evidence in the American Petroleum Institute (API) report. A stunning 6.9-million-barrel increase in supply initially caused a break in price. The API also reported a bearish 3.7-million-barrel increase in gasoline and a 598,000-barrel drop in distillate supply. Yet the numbers seemed to be out of whack and it is most likely because they were impacted by the closure of the Houston Shipping Channel, making the numbers less impactful.
We get the Energy Information Administration’s (EIA) report today. Yet it really is the stock market that matters. The correlation in oil and stocks are about as tight as they have been since 2016. Alan Konn of Price Asset Management points out that that the last time we saw this correlation oil bottomed.
We are hearing talk that at least one shale oil producer is on the verge of declaring bankruptcy, many are also wondering whether we are going to see more shale companies go bust. The EIA reported that the current crude oil price declines are similar to 2014, but some measures of U.S. oil producers' financial positions vary. The decline in oil prices, since the beginning of the fourth quarter of 2018, is of similar magnitude to the fourth-quarter price decline in 2014. After the fourth-quarter 2014 price decline, prices dropped further in 2015 amid high volatility for several years, which contributed to bankruptcies, consolidations, and closures within the industry. When comparing the financial positions of U.S. oil producers as of the third quarter of 2018 with the third quarter of 2014, most measures of profitability and balance sheet fitness indicate companies should be able to weather the recent price downturn. Oil price volatility and uncertainty remain high, however, and financial pressures could increase if prices continue to decline.
The percentage price decline from the beginning of the fourth quarter of 2018 through December 18 followed a similar path when compared with the same period starting at the fourth quarter of 2014. From October 1 through December 18, front-month West Texas Intermediate (WTI) crude oil prices declined 39%. In 2014, they declined 40% during the same period. A key difference in assessing the financial position of U.S. oil producers in 2014 compared with 2018, however, is that oil price levels were significantly higher in the years leading up to the 2014 price declines compared with 2018. In addition, in 2014 oil prices had already declined 15% from their highs in June by the start of the fourth quarter. In 2018, the start of the fourth quarter marked the highest prices of the year.
Given the different price levels, oil company revenues per barrel were significantly lower in the third quarter of 2018 compared with the third quarter of 2014. According to the third-quarter 2018 financial results of 40 U.S. oil companies, their median upstream revenue was $45.33 per barrel of oil equivalent (BOE). This same set of companies in the third quarter of 2014 had median upstream revenues of $64.57/BOE.
The 44 companies included then have been reduced to 40 companies because of consolidation through mergers and acquisitions. Another evident difference between these two periods is that the companies have significantly reduced production expenses since 2014, ultimately contributing to higher profitability despite the decline in revenues. Median company production expenses declined from $13.97/BOE in the third quarter of 2014 to $9.87/BOE in the third quarter of 2018. In fact, the median company's production expenses in the third quarter of 2014 would have been in the 75th percentile of production expenses in the third quarter of 2018, highlighting a broad reduction in production expenses among U.S. oil producers.
In contrast to the different operating environments of the two periods, measures of leverage (debt) and liquidity (ability to pay short-term liabilities quickly) do not appear to have significantly changed between 2014 and 2018. After the oil price decline of 2014, many companies restructured their balance sheets through debt consolidation, asset impairments, and asset sales. In the third quarters of 2014 and 2018, nearly all of the companies had long-term debt-to-asset ratios of less than 50%, meaning most of their assets were financed by the owners of the companies. Although no defined standard for an appropriate long-term debt-to-asset ratio for oil and natural gas production companies exist, the financial risk of inability to repay loans typically increases as the ratio increases. Alternatively, a ratio that is too low can indicate inefficient use of resources available for investment.
Even though measures of leverage between the two periods are comparable, this group of U.S. oil producers has slightly different measures of liquidity in 2018 compared with 2014. In the third quarter of 2018, 80% of the companies had a ratio of cash assets to short-term liabilities of less than 40%, compared with 66% of companies with this ratio as of the third quarter of 2014. Similar to leverage ratios, no standard ratio is considered adequate, but a higher ratio indicates that a company has more ability to weather financial downturns.