Oil investors have been left reeling as the world’s oil producing superpowers this weekend effectively tore up the price-supporting playbook that had steered crude prices ever since the last crisis.
OPEC+ (basically OPEC members plus Russia) have steered oil prices through production cuts and quotas since the wake of the 2014 crude market crash.
This year, Saudi Arabia-led OPEC has been seeking to further restrict supply, to keep a support under the market price but, evidently, it was a cut too far for Russia which declined to make a deal, refusing to hand market share to America.
The not-so-silent hands in the market have now come off the tiller. The OPEC+ cartel members will be free to pump as much as they like from 1 April.
Brent crude futures are presently down around 25% in London, with the May contract priced barely above US$36 per barrel whilst the April West Texas contract was down 28% at around US$32.
Oil crisis in supply and demand
So, the oil market now simultaneously faces a crisis of both supply and demand, as the coronavirus outbreak practically shut down China’s industry for much of the year to date and is now sweeping the globe.
Latest forecasts from the IEA, released today, envisage a contraction in global oil demand for the first time in over a decade – with the watchdog slicing some 1mln barrels a day off its 2020 estimate which moves to 99.9mln.
At that level the underlying crude demand would be about 90,000 bopd lower than last year, marking the first decline since 2009.
Fears of global recession had already risen in the opening weeks of 2020. This latest shock has now poured fuel to the fire and spiked volatility.
Rout in London’s oil stocks
London’s FTSE 100, which counts Royal Dutch Shell and BP among its weightiest constituents, began Monday’s session in outright capitulation falling 570 points to 5,893 in opening deals.
Shell shares were down 240p or 15% trading at 1,354p after an hour and half of trading, whilst BP shares similarly slumped around 15% to change hands at 337.45p.
Beneath the majors, London’s ambitious but debt-laden independent producers have seen yet more volatility.
Shares in Tullow Oil PLC (LON:TLW) - which mid-way through strategic review and under new management already had enough of its own internal problems - lost another 36% and now change hands at just 15p (versus around 225p this time last year).
That price gives a market value of just US$215mln to the West African oil producer, which generated about US$1.7bn of revenue off 86,700 bopd last year and had US$2.8bn.
Premier Oil PLC (LON:PMO), which had been set to acquire mature North Sea fields from BP and had US$1.99bn of debt at the end of December, saw its share price collapse 58% to around 26p.
Rockhopper Exploration PLC (LON:RKH) was set to finally build its Falklands oil field alongside Premier and its shares are down 28% at 8.62p.
North Sea firms EnQuest Plc (LON:ENQ) and Cairn Energy PLC (LON:CNE) respectively lost 17.5% and 20%.
Hurricane Energy Plc (LON:HUR) shares gave up another 21%, to trade at 11.38p, with the crude market turmoil adding pressure to the recent entrant to London’s ‘producer’ cohort.
Diversified Gas & Oil PLC (LON:DGOC), a more gas-centric producer onshore USA, this morning released its financial results against the wider volatility and saw its price drop only 1.9%. The acquisitive firm’s results confirmed that 90% of 2020 revenues are protected by hedging, and around two-thirds of next year’s prices are similarly covered.
What does it all mean for investors?
Setting aside broader macro-economics, the challenges can be boiled down into a few themes.
For the oil majors like BP and Shell the focus and fear will ultimately be quite narrowly be pointed at the threat to dividends – typically, such industry behemoths can ride out years of muted profitability and difficulty so long as they can protect the dividends paid out to their income focussed shareholder base.
Larger independents such as Tullow Oil and Premier, to name just two examples, potential face more significant and possibly existential threats as these firms essentially live on tightrope having previously established their businesses through debt finance.
Such companies are already under pressure to prioritise cashflow, maintain debt covenants, and, ideally, reduce levels of indebtedness. Dramatic drops in cashflow could quickly put them in hot water with their creditors.
As these upper tiers batten down hatches, new projects for future growth will slide decidedly into the background. This is obviously bad news for firms hoping to land a ‘sugar daddy’ partner via farm-out deals.
In the absence of farm-out activity, projects could mothball for the near-term at least. Some firms may be left to scramble for alternative or innovative funding solutions.
After that, for the broader cohort small cap oil and gas explorer, the narrative will most likely be all about cash, costs and working capital.
How much is in the bank, what are they obliged to spend, and can they keep the lights on without new fund raising? - these will all likely be key questions for investor in the sector in the coming weeks and months.