Looming Crude Clouds, Long-term Implications of Current Oil Crisis

The Looming Crude Clouds

The recent rally in oil prices from $26 in January to $47 in April has stirred hopes and shed some pressure from the confused, busy market players who are insinuating that oil has, finally, ‘bottomed out’. But, things are smooth neither at the surface nor at the bottom. The rig count, demand and supply disruptions; all are creating a perplexing situation where the weight seems to be equal on both sides of the continuum.

At present, if on one side, the oil market is symptomatic of rebalancing, Saudi Arabia has also increased its production in April, on the other; Libya has also decided to jump on the bandwagon while Russia and Iran were already in the line. The effects of outages in Iraq and Nigeria have been repudiated by the increase in production at other points. What’s interesting here is the very aplomb the markets are brimming with right now. While analysts warn that this rally is a deceptive one, others are quite confident of its sustainability.

There is an amalgamation of good and bad indicators: the recent surge in vehicle demand from China, supply disruptions in Nigeria and Iraq and the slump in US production. Following this downward trend is the ‘rig count’ which, according to Baker Hughes, has been at the lowest level since 1990s. On the other hand, the Doha meeting has reaffirmed the fears of most market analysts as the Saudi-Iran feud poured cold water on all the high hopes attached to this meeting. Although a draft was formulated by the participating countries, yet the provision of monitoring the production freeze “in good faith” insinuates the seriousness behind, and effectiveness of, the deal.

It is also interesting to note that during 2015, when companies were posting unprecedented losses, some of the oil traders have been lucky enough to reap immense profits due to the condition called ‘market contango’ — where the future prices are higher than the current prices. The purpose of this article is to give the readers an overview of the pecuniary decadence the oil companies are facing and, secondly, that how this crisis is going to leave countries inflation-smitten, capital-worn and politically-distorted. Also what elixir the big countries are cooking in their cauldrons to cure this economic scourge.

Let’s start with oil companies; following are some of the facts and figures appertaining to the big names in oil business.

Oil Companies’ Profits and Project Cuts

Drilling and exploration projects of around $380 billion (68 projects) have been slashed out during recent years due to reduction in profits of oil companies; only 10 new projects are likely to be executed in 2016 while before this price crash the number was around 40-50. In the United States, which was the prime target of this oil war, there has been a continuous fall in rig counts. The EIA has reported that the production in US has also come down the 900,000 barrels per day mark.

Oil giants like Chevron, Royal Dutch and BP; all are making job- cuts and posting losses to the tune of billions of dollars. For instance, BP claimed to lose $3.3b in the fourth quarter of the previous year i.e. 2015 while ExxonMobil lamented the 58% decline in its quarterly gains. This pain was shared also by Royal Dutch Shell whose profits fell by 56% in the said period as its earnings dropped to $3 billion from $19 billion in 2014. The third largest American oil company, ConocoPhillips, posted a $3.5b loss in fourth quarter, compared with a net loss of $39 million in 2014.

Up to 65,000 jobs have been cut from British offshore oil business while BP and Shell plan to cut another 4,000 and 2,600 jobs respectively. 37 North American companies have filed for bankruptcy.

The ExxonMobil lost its AAA credit rating on Standard and Poor’s; it’s AA+ now. The very reason behind this lower rating is the swelling debt that has almost doubled within a year.

But why should a common man worry about oil companies getting grinded?

These oil companies, actually, are huge organizations — very huge, indeed — and a hefty part of government revenues comes from the taxes of such oil giants in major oil-producing countries. Hence, the plight of these companies bodes ill for the overall economy. Countries like KSA, Russia and Venezuela, for which the oil is a major source of income, are facing a plethora of issues.

Russian Tax Policy

In March this year, Russia introduced a new tax policy but it is believed that it will only exacerbate the current issues oil companies are facing. Before examining the havoc the new tax policy may wreak on the oil firms; let us see how oil taxation actually works. In a recent article on an online website Vox, the writer explains that when oil was selling around $100 a barrel, about $74 of it was going to tax and then subtracting the cost of shipping and production, the firm is left with $10-11 profit/barrel. When oil was trading at $30 one can imagine the plight of the oil corporations under the light of the aforesaid taxation process. For Russia, half of the government revenues are dependent on oil; making the long-term insidious effects inevitable.

Moreover, this fall in profits sends ripples across the stock markets and when the bourses are wavering, the total economy of a country falters as well. Another thing is that oil companies borrow heavily from banks. But, since per barrel price of oil is going down, banks are facing perilous prospect of defaults. This, in turn, affects the profitability of the banks and also hampers their ability to grant loans to businesses; thus triggering a domino effect in which consumers, government and the international economy are the stakeholders.

Plans for the Future

For countries whose budget dependence on oil revenues is so heavy that even a one-dollar drop in prices would matter, it is incumbent to improvise new plans for the future. Recently, we have witnessed many developments, like the National Transformation Plan of Saudi Arabia, in the major oil producers’ policies; however, before adumbrating this plan, let’s consider the dire consequences which will befall those who are not adjusting their sails to the direction of the wind.

After the oil crisis of 1973, there was a paradigm shift in the oil business. The crisis, which emerged as a result of the Arab-Israel War, helped West realize their sheer dependence for energy on the Middle-East and that the players controlling the supply were all but dependable and friendly.

For countries, which solely depend on oil, the falling oil prices is a serious issue. Why? Because their total revenue pares down and their budgets get disturbed which further affects different sectors of country’s economy. Public sector suffers, development programmes face hindrances, financial sector is directly affected and due to this, the business and industrial sector also gets paralyzed. Governments remove subsidies and prices of products are raised; thus burdening on the common man further increases. The income level of the population falls and what follows are protests, agitation or other such things which often take no time in turning into government ousters. Gaddafi’s takeover of Libya and the Iranian Revolution are fine examples in this regard. Though the conditions are not grim as of now, yet its possibilities cannot be ruled out. Venezuela is a case study. Inflation levels, there, are record high i.e. 180%; the contraband market is burgeoning manifolds. Venezuela’s 95% of exports consist of oil and it contributes 25% to its GDP. The falling oil prices are taking their toll on health, education and other sectors and are increasingly turning into protests.

In Saudi Arabia, budget deficit has reached to 15% of GDP — 90% of Saudi budget comes from oil revenues — and there is a surge in water, electricity and petrol prices. The country has already depleted $100 billion of its forex reserves.

Russia, too, is facing a double-whammy as the crippling sanctions along with the drastic plunge in oil revenues has put the country under financial pressures; inflation is soaring and then there are the expenditures which its intervention in Middle East has increased manifolds.

Saudi Arabia’s National Transformation Plan

On 25th of April 2016, Saudi Arabia’s Mr Everything (as the West calls Saudi Deputy Crown Prince Mohammed bin Salman) unfolded the Kingdom’s ‘visionary plan’ for the coming years. Its core is the establishment of a $2 trillion sovereign fund — the largest-ever and big enough to buy the four biggest companies of the world: Microsoft, Alphabet, Apple Inc., and Berkshire Hathaway Inc. This fund will be set up by floating 5% shares of the world’s biggest company — Aramco. Before digging deep into the Plan, let me first give you coup d’oeil of the bravura of this oil giant. First of all, it’s one the most secretive companies on the planet with little or no information available of its financials. It’s a company with the prowess to pump 12 million barrels of oil per day and which owns the biggest onshore (Ghawar field) and offshore (Safinya field) oilfields in the world. Its net worth is believed to be $4 trillion which is 10 times to that of the largest publically-quoted company i.e. Exxon Mobil. Some estimates put its worth at around $10 trillion. It is also the world’s fourth biggest refiner. Moreover, it boasts 260 million barrels of oil reserves (second highest oil reserves after Venezuela).

Saudi Vision 2030

On April 25, Saudi Arabia unveiled its Vision 2030 plan which enunciates different measures which the kingdom plans to execute in order to wean itself off oil. The reason behind launching this transformation plan is that Saudi Arabia is now aware of its dwindling hold over the oil markets and its capacity as an oil swinger. It no longer enjoys the 1973’s power when it could manipulate black gold by turning on or off the taps. Also analysts are of the view that this plan has nothing to do with the oil policy in the sense that the current oil war will continue as it is, battle for the market share is another thing and the Vision 2030 another. In an interview to Bloomberg, Prince Salman said that they can pump up to 12 million barrels per day, if they wanted to. He sees more “opportunities than problems”.

According to the Plan, the kingdom will sell 5% shares of Aramco and it will help them create the abovementioned $2 trillion sovereign fund. Furthermore, Aramco will be transformed into an ‘industrial conglomerate’ which will not only pump oil but will also become the world’s largest refiner.

The Plan envisages increasing the non-oil revenues from $43b to $267b by 2030. There is also a provision that gives expats the right to work there for long-term. This policy coincides with the future plans to boost the manufacturing sector along with ventures in mining sector and to do this, they need workforce. Apart from economic reforms, there are also talks about increasing women participation and educational amendments.

Apparently, this plan is very appealing but its implementation can face adversity and trouble from within the Al-Saud family as the hardliner and extremist elements will never allow such drastic changes to be implemented and that too with such ease.

US Shale Future

The US shale producers have, hitherto, proven quite efficient as the Saudi strategy to oust low-cost producers has not been utile. As rig count has fallen to its lowest level, the US production has also taken a dive from high of 9.7 million bpd to 8.9 million bpd. However, there’s the catch-22; the production has suffered due to the continuing fall in prices but now as the prices have soared to $46 a barrel, it can bring back the gone-home producers or at least prevent the incumbent ones from packing up.

I genuinely feel that oil has bottomed out and that, as per IEA’s March report, we will see an act of market re-balancing in 2018. The sentiments of the investors even after the failure of Doha meeting corroborate the aforesaid thinking as they too seem focused on the pleasant picture which they can see standing in the midst of a convalescing yet precarious oil crisis thinking that the worst is over. The giant of oil has suffered much injury as it has fallen from a very high spot but it seems that he is getting up and starting to climb its way back to the top.

Written by: Osama Rizvi

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