What are the recent updates from the global oil industry?
The recent drop in oil prices is caused by supply and demand issues. On 5-6 March 2020, OPEC and non-OPEC oil producers met in Vienna to discuss oil production and prices in the wake of weakening global demand due to lower global economic activity in part due to the impact of the coronavirus (COVID-19). The meeting concluded with Saudi Arabia and Russia not agreeing to cut production to increase the price of oil. This has resulted in Saudi Arabia and Russia embarking on a production war to capture increased share of the global oil market regardless of the implications for the price of oil. This is the supply issue for the global oil market, with production significantly increasing while exceeding demand, global oil prices dropped significant to around US$35 per barrel from US$55 – US$60 per barrel. On the demand side, COVID-19 is causing a fall in global oil demand, putting further downward pressure on global oil prices.
What has been the United States response?
President Donald Trump announced on Friday (13 March 2020) that the US Department of Energy would purchase crude for the nation’s strategic petroleum reserve. This is response is in light of severe pressure on US shale producers that are unable to compete with Russian and OPEC oil that can produce at a lower cost compared with US shale oil.
What has happened to Australian oil producers?
On 9 March 2020, the ASX Energy Index fell 19% due to continued concerns surrounding the Saudi Arabia and Russia production war. The share prices of Australian oil producers fell significantly, in particular, BHP Group Ltd (ASX: BHP) fell 9%, Oil Search Ltd (ASX: OHS) fell 23%, Santos Ltd (ASX: STO) fell 23% and Woodside Petroleum Ltd (ASX: WPL) fell 17%.
The main reason for Australian oil producers share price to fall so significantly is that a sharp reduction in global oil prices will reduce profitability as the cost base for producing petroleum products is largely fixed. Another point is that Saudi Arabia and Russian oil producers can generally produce oil and a lower cost compared with Australian producers, which again adds additional pressure for Australian oil producers to outlast this production war.
What is the outlook for oil prices?
The short-term outlook for global oil prices is negative. On the supply side, it is unclear whether Saudi Arabia and Russia can come to an agreement to cut production in order to increase the global price of oil. This is considering both countries have publicly announced that they have the capacity to last out this production war for several years. On the demand side, the continued spread of COVID-19 should lower the demand for oil, as cities are in lock down, major airlines around the world have cut international flights and global economic activity weakens.
Australian investors exposed to the oil industry or would like to gain exposure to the oil industry should closely monitor developments in the global oil market in coming months. There will be a point when the price of oil will bottom, and this provides the opportunity for investors to acquire exposure to the oil sector at a cheap price.
This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
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