Financial Analysis of Oil and Gas Market – February 2017

VCI, a global consulting firm published an analysis of on oil and gas financial health. In it, VCI indicates that despite the near record increase in U.S. oil inventories last week – an increase of 13.8 million barrels – oil prices traded up in February.

The abnormal crude stock increase took inventories close to 80-year record levels at 508 million barrels and is evidence that should worry oil bulls. However, the oil markets were not deterred. In fact, that has been a defining characteristic of the market in recent weeks – optimism even in the face of some pretty worrying signals about the trajectory of the market.

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Wall Street is allocating the most money to U.S. energy companies since at least 2000 amid growing confidence that the industry is emerging from the worst downturn in a generation. Energy firms raised $6.64 billion in 13 equity offerings in January, drawn in by a rich combination of oil prices consistently above $50 a barrel and a rush to drill that’s doubled the rigs in use in the U.S. and Canada since May.

Already, companies such as Weatherford International are able to charge more for the use of their equipment and services as explorers race to open the spigots in the fertile Permian Basin of West Texas and other U.S. shale fields.

The industry should see more activity this year as companies rush to conclude deals ahead of the rebound. With a favorable environment and deregulation by the Trump administration, M&A activity will rise substantially in 2017. E&P acquisitions and divestitures dropped off when commodity prices collapsed in late 2014, but have significantly ticked up since mid-2016.

A lot of the action, unsurprisingly, is occurring in the Permian Basin. ExxonMobil spent more than $6.6 billion in January to double its holdings in the Permian. 2017 is expected to be even larger than 2016 in terms of the value of deals in the Permian. Last year, the industry spent $24 billion in mergers and acquisitions, a colossal sum that turned the basin into the hottest play in the country. With such heavy deal activity in the Permian Basin, the valuations of some deals may have become too frothy.

The boom in the Permian Basin will now lead to a rash of deals in the midstream sector, as more pipelines are needed to carry the larger flows of oil. In short, the sentiment in the oil patch continues to improve even as oil prices have faltered in the low to mid-$50s per barrel. The flood of money back into the industry portends a strong rebound in 2017. It could also leave a lot of people and companies on the hook if oil prices fall back again. 

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I agree with this assessment. It is difficult to justify investors optimism especially when numbers do not match. 

For instance, OPEC’s agreement to cut crude oil production was quickly offset by a rapid increase of the U.S. output. The U.S. shale producers have flexibility due to the nature of operations related to the development of unconventional reserves as well as improved technology and a large number of DUC.  It enables them to react relatively quickly on any sign of crude oil price improvement. Ironically, the same flexibility is likely to be one of the major factors that lead to a sustained low crude oil price environment.

The other factor that may contribute to the low oil price is Donald Trump’s unpredictability and severe swings in his position on major political events. In addition, Trump’s policy of isolationism represents a high probability that global economy growth may be restricted or stagnated, or even would start to shrink.

The dramatic change in his assessment of China, from currency manipulator, the country that rapes the U.S to his recent statement that Xi Jinping is a terrific person and there are no more currency manipulations, is another very worrying sign. It suggests that it is likely that trade war could start in the near future. Because there is no assurance that he will not change his view again soon.

We also shall not forget that the current Commander-in-Chief of the United States misdirected the USS Carl Vinson aircraft carrier (or should I say that he lost the ship) at the pick of a military standoff which almost led to a conflict with potentially irreversible consequences. It is an unprecedented illustration that the world stability may no longer be the reality.

The recent announcement by the U.K Prime Minister Theresa May to call for a snap general election, despite the fact that she repeatedly ruled out calling an unscheduled election, is a clear indication that Brexit negotiations will be very tense and complex.

Although it is difficult to forecast the outcome of this process, the range and high level of importance of the issues that the U.K. will negotiate with the E.U., strongly suggests that in the best case scenario the U.K. economy will sustain substantial impact. However, in the worse case, the Great Britain might lose its territorial integrity due to Scottish referendum which may take place in the future.

There is no doubt that as a result of the Brexit process, the economy of European Union will also be affected.

With the above factors in place, it is doubtful that we shall expect an increase of demand because the events that shake the world’s top driving economies leave little or no chance to witness economic growth. Without higher demand, it is not reasonable to expect improvement of the crude oil price.

It is also necessary to mention that renewables become cost-competitive. With the climate change agenda, the renewable sources of energy may decrease the share of oil and gas in total energy consumption. It will also influence the oil price.

The Federal Reserve decision to increase the interest rate means that the industry’s corporate debt would become heavier. Whether oil and gas companies are able generate sufficient cash to meet their short and long-term obligations remains to be seen.

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