BIG OIL MIGHT FARE BETTER THAN STATE-OWNED COMPANIES
Crude oil, once used to be called liquid gold, is plumbing the depths only The Economist had dared to predict. The Economist, London-based magazine founded by 19th century most prominent public intellectual, Walter Bagehot, had written that oil price would slump to $5 per barrel. After that, oil price had often shot through the roof and it was inconceivable that oil should ever be cheap in the heydays of global capitalism.
Now in the whirlwind of the coronavirus pandemic, oil is falling. On Monday, West Texas Intermediate (WTI), a benchmark oil for the US market, fell to $11 a barrel. There are reports oil prices are approaching the negative territory in the US, and at one point it did cross the zero mark! Meanwhile, the global benchmark price for Brent crude touched $21 a barrel.
These prices for crude oil were unthinkable as there was a time, not too distant in the past, when oil prices were shooting past $100 a barrel and leading producers, including Russia, were confidently predicting that oil price should touch $200 a barrel. It was heady time for that country since its entire budget depended on revenues from exports, with the rest of the Russian economy having collapsed.
So very different reality today.
Amid the global lockdown in the face of fast spreading coronavirus pandemic, oil demand has almost evaporated. There is little need for oil nowadays. Transportation on the roads has ground to a halt and aviation companies are shut with no flights. International trade having been badly hit, shipping movements are also limited. Who will need oil now for the internal combustion engines?
The oil producers are caught in a bind. The national oil companies, which constitute a big part of the global oil industry, are pumping their oils, as most of the oil exporting countries depend heavily on the product for their national survival. The multinational majors, which are purely the traditional Big Oil firms, are finding it difficult to slam the brakes on of a sudden on technical reasons. As a result, what is happening is that oil stocks and inventories are spiking and at an unmanageable pace.
So much so, that some of the experts are predicting that soon enough oil prices would enter the “negative zone”. That is, producers will pay some little discount to encourage buyers to pick up oil from their stocks and relieve the warehousing pressure. The financing costs of holding such enormous oil stocks are also too heavy to withstand for long.
If large shades of the global economy continue to remain locked down, soon a point will be reached when both for the NOCs and Big Oil will find running the wells costlier than altogether slamming the brakes.
It is at that point that the major oil producers will start shutting down the existing wells to stop booking mounting cash losses. Whether that scenario will in fact come to pass will depend on the course of the coronavirus throughout the world. At present, there are no signs of the virus pandemic abating anywhere in the world.
The coronavirus pandemic has now broken out in all the countries in the world, including some remote islands in the midst of the oceans. Reunion Island, right in the middle of the Atlantic Ocean has also reported some cases, as also islands in the far off south Pacific.
Countries which are abjectly dependent on oil revenues are biting the dust and fast blowing up their national reserves. Russia was going through the lower end of the economic cycle already, and the current spread of the virus in that country is decimating its economy. Saudi Arabia, once the petro-dollar minting centre, is scrapping the bottom of the barrel. Its crown jewel, Aramco, targeting to become the largest in the world in terms of market capitalisation, could not be too hung up about that position.
With serious drop in prices, Big Oil companies, which in normal times have bigger annual revenues than the GDP of even some middle level countries, are wondering how to meet their cash and operational expenses. Even when oil is not selling, these companies, because of their humongous size and scale of operations, need large amounts of funds. Theirs have become an existential question in the current situation.
For the oil consuming countries, who are larger in number than oil producing ones, cheap oil would be useful, the sheer drop in prices and the financial distress of the oil companies are not things to rejoice.
The global economy has not yet come to a state where it can renounce the internal combustion engines and altogether shift to other fuels. So for the foreseeable future, a semblance of stability in the international oil industry will be critical
How the future of the oil industry should be depends on a large extent on the investors in oil resources —both commodity investors and those who buy oil bonds, equity and other financial products. .
Investors and financiers are taking fresh calls on placing their funds in oil as a commodity and in oil companies equity and bonds.
Goldman Sachs has done an analysis of the rating prospects of big oil companies, the potential for meeting their debt servicing obligations, their overall resilience and, finally, the value of their equity and ADRs in the context of the falling oil prices and demand.
GS had done the study on the basis of analysis of their balance sheets and on various oil price scenarios in the context of the failure of OPEC+ meeting and the sudden explosion of the Corona virus pandemic driving down oil prices.
Overall findings are that:
The overall breakeven price level for Big Oil companies have fallen to $40-45 from $50-55, as opposed to $80 for the state oil companies of OPEC. Consequently, the Big Oil companies are better placed to survive at these low oil prices than the state oil companies of OPEC.
For the Big Five, CAPEX and OPEX flexibility gives them sufficient maneuverability to manage in times of crisis like the present. This allows them to release operating working capital in times of macro-economic instability and commodity market upheavals. GS has estimated a 35% cut in OCF for 2020 and 15-20% cut in CAPEX for the EU majors.
At a $40 oil price scenario, the Big Oil companies will still retain their overall credit at A or A/A level on the basis of overall cash flow to net debt ratios. Of course, even that will mean some credit downgrades.
The Big Oil companies will have enough liquidity in their hands as their overall cash flow requirements will go down and release liquidity. Their current liquidity is twice their maturity obligations. Big Oil companies are estimated to have sufficient liquidity on hand to meet their obligations in 2020 and 2021.
The sharp downward revision of CAPEX has also brought down their requirements of funds and debt servicing obligations.