Crude price rise boosts company valuations

08 May 2018
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Ice Brent crude recently rose above $80/bl for the first time since late 2014, increasing oil producing companies’ profitability

Benchmark crude prices have risen to their highest levels since November 2014, when they were months into the decline that started in the summer of that year. Reasons for the price rise are relatively clear, with Opec members and some non-Opec producing countries including Russia still operating under a production-constraint agreement and Iranian supply set to be reduced as a result of political pressure over the Islamic republic’s nuclear programme at a time of firm global demand growth. An additional factor supporting price is that the market is moving into the summer season, when demand for road fuels peaks and some countries – notably Saudi Arabia – supplement power generation by burning oil.

The higher crude prices seen in recent weeks come after years of depressed prices, during a period when global oversupply damaged producers’ balance sheets, driving Opec and others to join in the agreement of a production ceiling in an attempt to support the market. During the time of depressed prices, producers worked hard to reduce costs in order to protect profit. Because the effects of the cost-cutting measures remain in place, the recent rise of benchmark prices is having an enhanced positive effect on many companies’ balance sheets.

Some companies are responding to the price upturn by launching share buyback programmes. European majors including BP, Total and Royal Dutch Shell are taking this path, indicating that the industry knows that it has the opportunity to improve investor returns as it recovers from the four-year downturn. The deep cuts made during the downturn reduced average operating costs per barrel by around 33pc and field development costs by around 50pc, creating a situation in which higher oil prices translate much more quickly into higher profits.

US majors including ExxonMobil and Chevron are reaping the benefits of the price upturn, but there is a question over whether producers focused on unconventional production from shale formations are feeling the same benefit.

 

Some companies are responding to the price upturn by launching share buyback programmes. European majors including BP, Total and Royal Dutch Shell are taking this path, indicating that the industry knows that it has the opportunity to improve investor returns as it recovers from the four-year downturn.

The Nymex WTI crude benchmark has risen in line with higher Ice Brent prices, but US shale producers have been facing higher production and transport costs, meaning that the rise in benchmark prices is taking longer to translate into higher profits. This effect is largely an unintended consequence of the prodigious rise of US shale oil production in recent years. This rise, despite the provision of increased pipeline infrastructure to move oil to market, has led to a situation in which production has again grown beyond the capacity of available pipelines, forcing producers to use more expensive methods including road and rail. The effect of this on some balance sheets has been deepened by the fact that companies active in, for instance, the Permian basin and the Bakken formation have increased investment in drilling operations.

But the dampening of the effect of higher crude prices on the profitability of US shale producers is not applicable across the board. For instance, Marathon Oil posted first-quarter results that indicate a strong turnaround, with quarterly adjusted income of 18¢ per share, up from a loss of 7¢ per share a year earlier. This rise in profitability is attributed to higher output, with first-quarter production almost 21pc higher year on year.

The slow rise of profitability for US shale producers is likely to be short-lived if prices continue to move higher, as increased profits will simply take longer to materialise in a context of higher breakeven costs than those of conventional producers. As we move into the peak summer demand season, it is likely that – all things remaining equal – higher benchmark crude prices will push the US shale sector into a position to benefit.

 

 

 

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