The house of oil

Equity markets started the second week of the year in a similar vein to the way they started the first week, with a great deal of uncertainty. We highlighted at the start of the week that a couple of leading investment banks have suggested a technical bounce is due as equity markets look “oversold”. JPMorgan have been extremely cautious for several months, added their support for this view in a research piece on Monday.

Overnight on Monday there were a couple of pockets of news that may assist the markets to bounce from their oversold levels. Firstly, slightly better consumer data from China as auto sales rose over 8% year on year. Sales of cars around the world continue to rise despite the uncertain outlook. The lower oil price may be having a mixed impact on the global economy, but it appears to continue to boost car sales. The US recorded sales of over 17 million new cars in 2015, surpassing the record in 2000. Likewise, Britain recorded its highest number of car sales in 2015.

The other piece came as Alcoa reported numbers late on Monday, revenues came in slightly behind expectations, earnings manage a beat. The company reported that they expect demand of aluminium to grow modestly this year,

The oil price bears remain in ascendancy, charts suggesting the long-term oil price is anything between 20 and 25 dollars a barrel, are being distributed from brokers research departments. These charts were conspicuous by their absence when oil was $115 a barrel! We are now within 10 to 15 percent of that range.

This fall in the oil price and subsequent impact on the industry is beginning to feel a similar to what happened to the housing stocks in 2008, as banks were unable to lend. The industry looked as if it was about collapse, Taylor Wimpey and Barratt shares were down to a few pennies. You were left wondering who was going to build a new house. In the end governments supported the industry and the shares have returned multiples in the past few years.

Many of the established exploration and production oil companies share prices are on their knees, the likes of Tullow and Premier oil, suggesting they may not survive prolonged weakness in oil prices. Oil demand may be slowing, due to developments in technology amongst other reasons. Supply is plentiful at present, but the world still will be requiring oil for many years to come, rather like houses.

Digging oil out of the ground is expensive requiring large amounts of financing, which only banks can provide. The banks have been financing projects, but probably using the wrong oil price assumption. Oil production has grown materially over the past 30 years, based largely on a belief of an undying demand from China. At $25 a barrel most projects are uneconomical in today’s age, the Shell BG deal requires over $50 a barrel. Crisis, history tells you brings opportunity, this oil price fall will, with hindsight once we believe again prove this to be the case, rather as the housing market did in 2008. As always it’s a matter of timing waiting for the turn not trying to predict it. 

Posted on January 12, 2016 .