Crude Oil Prices To Decline: Winners And Losers

Last week, the Organization of Petroleum Exporting Countries (OPEC), along with its Non-OPEC allies, announced its plans to release an additional 600 thousand barrels of oil per day (kbpd) into the oil markets in the coming months, altering the earlier agreement to restrict its supply until the end of 2018. The move is largely driven by Saudi Arabia, the de facto leader of the OPEC, and Russia, one of the largest Non-OPEC oil producers, who aim to capitalize on the rising oil prices to anchor their deteriorating economies. A sharp jump in output in the already oversupplied global oil markets is likely to result in a drop in crude oil prices over the next few months. Consequently, we have revised our forecast for 2018 Brent oil prices to $67 per barrel using our interactive dashboard.

Winners

Downstream Businesses

One of the key winners in a low oil price scenario are the downstream businesses that utilize crude oil as an input in their refineries and marketing operations. A drop in the oil price leads to lower fuel expense for these businesses, boosting their refining margins and profitability. On the one hand, there are many US refineries namely Valero Energy and Marathon Petroleum that are likely to enjoy higher profits in the coming months due to lower oil prices. On the other hand, integrated oil and gas companies, such as Royal Dutch Shell and Exxon Mobil, who have diversified their upstream businesses with notable downstream operations, will also witness a jump in their downstream margins.

US Airlines

Fuel cost constitutes roughly 30% of an airline’s operating cost. Since airline fuel is a by-product of crude oil, a decline in oil prices is expected to cause a drop in the fuel expenses. With the recent move by the OPEC, we expect the profitability of US airlines such as Delta Airlines, United Continental, and Southwest Airlines to surge in the next couple of quarters. Further, since American Airlines does not hedge its fuel consumption, unlike its peers, is likely to experience higher profits and margins for the remaining quarters of 2018.

Losers

Exploration And Production (E&P) Companies

The most obvious loser in a weak oil price scenario are the exploration and production (E&P) companies that explore, produce, and sell crude oil and its by-products in the global markets. Weak oil prices would result in lower price realization for these companies, causing their revenues as well as earnings to drop significantly. Independent E&P companies, such as Anadarko Petroleum and ConocoPhillips, are expected to witness a decline in their price realizations as the oil prices go down due to the OPEC’s increased supply in the coming months. However, EOG Resources‘ low cost structure and focus on premium drilling locations will allow it to sustain its margins and continue to be the market leader even as oil prices remain soft.

Integrated Oil & Gas Companies

Just like the E&P companies, large oil and gas giants such as BP and Chevron, who have notable upstream operations, are anticipated to see a decline in their price realizations, and, in turn, revenues due to low oil prices. However, since most of these companies have downstream operations, they are likely to recoup some portion of their upstream losses from the higher downstream profits.

Oilfield Services Companies

Lastly, oilfield service providers are expected to face a difficult time gaining new orders for their rigs. This is because as oil prices fall, the profits of oil and gas companies are likely to take a hit, which will impact their cash flows. A tight cash flow position will prevent these companies from investing money into drilling and exploration of new sites and deploying new rigs. Rather, they would work toward producing more from their existing wells at minimal cost. Consequently, oilfield service companies – Schlumberger and Halliburton – are expected to witness a decline in the demand for their rigs, pulling down their top-line as well as earnings in the near term.