Thursday, December 31, 2015

Evaluating A Year In Oil

It's finally the end of the year, and oil producers across the globe sigh in relief as one of the worst years in crude oil trading finally closes. But as they turn around to face 2016, the shaky ground they tread provides little respite of the past 365 years. Losses for the WTI and Brent spot prices amount to about -38% and -43% on the last day of the year. Both petroleum benchmarks underperformed other commodities traded on that market with general losses for the year traced by a plunge of about -23% for the CRB basket index. Because of these drops, commodity-based corporations, like Glencore, saw major squeezes on their top lines as slashed prices put many firms in danger of default. Exploration and production companies tracked by the S&P Sector Select ETF saw a total yearly return of -37.5% compared to a general S&P yearly loss of about -0.8%. There's no question when it comes to deciding the losing sector of 2015, that is if investors found themselves with a long position. On the other hand, short selling energy stocks became the favorite hobby of the average trader which exaggerated losses of energy shares across the board. Valuations of those same companies became increasingly expensive as average PE ratios steadily increased throughout the year due to a deterioration of the revenue stream. To keep up, investment spending cuts were forced across the board, and some companies even shrunk their workforce. Exxon-Mobil's price-to-earnings ratio is expected to jump from its 2013-2014 number of 13.3x to an even 20x for the year of 2015. Sales for the oil major will have decreased almost -37% on the year with a -15.5% decrease in the net assets on the balance sheet. This trend will be evident throughout the oil and gas industry as fourth quarter and yearly reports begin to emerge in January.

This leads to the next problem facing oil corporations at the end of the year. How will they evaluate their assets and performance of this year to reorganize for success in the next year? These entities will see major haircuts to their size and power going into 2016, a year that will no doubt feature another bout for market share by the looming Saudis. Because companies evaluate their current reserves using a spot price based on the past year, those assets will see major devaluations even if they've seen no change from the previous year. For example, an untouched pocket of crude oil discovered in 2014 would have been valued at an average price of about $80 a barrel in 2015, but because WTI and Brent prices have plunged this year, those assets will now be priced around $50 a barrel. Thus, all of the implied wealth that was created when prices were supported by OPEC will disappear. At first, this sounds like a good thing as share prices may see a reduction in swelling that occurred during the energy boom caused by high oil prices. But then we have to remember that hundreds of millions, if not billions, of investor dollars have been invested on this conjectured wealth and could be lost like the popping of a mini-bubble in this sector. That not only heaps tons of bearish sentiment onto the energy market, but it eventually spills into other sectors that may be sensitive to the weakness. Low oil prices have also been blamed for a dramatic drop in inflation that has hurt wages and earnings across the country but failing to spark consumer spending. The economic dynamics just mentioned definitely do not line up and are causing major debates in the monetary and fiscal stages in how to fix it. The Federal Reserve will continue its goals of increasing the Federal Funds rate which has been linked to better overall commodity performance by intermarket analysis. At the same time, a drop in investment spending in the energy sector threatens the surging shale production that has caused such a glut.

So that moves us into the extraction statistics. For 2015, both American and OPEC producers increased their production with domestic oil and gas companies only beginning to pull back in the latter part of the year. During a December meeting, Saudi Arabia and Iran lead the member countries' output to new highs that was augmented by the relaxation of a 30 million barrel a day quota. In the same month, Iranian production increased 119,000 barrels to help total OPEC production jump 18,000 barrels. U.S. output remains steady at 9.18 million barrel a day for the month, barely down from the 9.5 million barrel a day peak. Various International Energy Agency reports have estimated an 800,000 barrel a day decrease in the coming year, but many analysts have already underestimated the power of cutting costs. Look at analysts this year. Rigzone cited a Reuter's survey that averaged 31 projections for the 2015 year. That result is almost $20 over the current price at $57.95 a barrel.


That's definitely one thing that took me by surprised as I constantly heard about the new analyst projection. Most, if not all, were completely off the mark with either hope of a steep recovery or fear of another plunge. With prices starting just around the $50 mark at the beginning of the year, the analysts appeared reasonable with a $8 increase projected for the next 12 months. Not crazy, but definitely positive and bullish. It's possible that the expertes guessed that spending cuts would lead to larger production cuts, and once again, they might have underestimated the power of technology in cutting costs. The shifts in market power might have also been underrepresented in the projections because of the power OPEC typically has. For 2016, similar predictions are being formed. Meanwhile, the future price curve continues to get flatter with only $5.00 separating the latest 2016 contract and the current spot price. These prices communicated by investors reflect the burgeoning bearish momentum that might continue into 2016, and it may flood onto the trading floor. As analysts gather their research once more, it will be interesting where they place their this time around.

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