MARKET ACTIVITY / TRADING NOTES FOR DAY ENDING TUESDAY, MAY 26 1998 (4)
CHEAP OIL, Con't
Predicting Pump Prices
Fred Maxwell, whose company operates 148 wells in East Texas, wants oil prices to rise.
"A year ago, my bottom-line profit was 25 percent [of revenues]," Maxwell says. "Right now, it's not. It's zero."
Maxwell's Mustang Operating Co. has had to shut down 12 wells since January because he can't afford to repair them. He's had to lay off two field laborers from his 14-person staff. "It's just a rough period of time to get through," says Maxwell, who's been in the drilling business for a quarter century.
While Maxwell's business will improve if the price of oil rises-he's hoping for $17 or $18 a barrel rather than the $14.50 he's getting now-other parts of the economy will more likely suffer.
In fact, economists warn of higher inflation rates and higher unemployment rates when the price of oil rises.
Political Problems Pose Threats How bad will it get? Petroleum pundits differ, but the consensus is that it will take political destabilization in several oil-producing countries to cause a catastrophic rise in the price of oil.
Even if a price rise isn't catastrophic, it will cause hardship.
The higher cost of gasoline, heating oil and other fuels means that consumers will have less money to spend on other items, lowering their standard of living and cutting demand for other goods, says Gordon Richards, an economist with the National Association of Manufacturers.
As power and transportation costs rise, businesses will suffer, too, Richards explains, citing the patterns of earlier oil crises. Businesses will likely have to raise prices, sparking inflation. The government will fight that inflation by using higher interest rates to tighten the money supply.
While inflation might subside, businesses will have to cut costs by laying off employees, resulting in higher unemployment rates. "That tells the story pretty much as it happened in the 1970s," Richards says.
What's Behind Possible Boost?
The question is, what will drive oil prices up, and when? The most likely scenario, analysts say, starts with lower supply. Producers around the world are holding back on increasing supply because it's uneconomical. Or, as in Maxwell's case, operators won't even maintain current capacity.
It's also possible that the Organization of Petroleum Exporting Companies (OPEC), which agreed to cut output earlier this year, will decide to make further production cuts in June.
Meanwhile, demand is rising, partly encouraged by lower prices and partly by worldwide economic growth, though troubles in Asia have made it slower than expected.
"It looks very much like the markets are correcting as we speak," says Arthur L. Smith, CEO of John S. Herold, an independent petroleum information services company. "By this time a year from now, we could be looking at a much tighter market."
Where prices will eventually end up is probably about $5 more a barrel than they are now, says Stephen Smith, an oil analyst with Dain Rauscher Wessels. But that won't have a significant hit for people at the gas tank, he says, since each dollar per barrel amounts to 2 1/2 cents per gallon of gas-a total of 12 or 13 cents.
Low Risk of Catastrophic Rise
A catastrophic rise, observers say, would stem only from political instability affecting several oil-producing nations-a regional war, for example. "The risk would be another international incident, maybe in Russian oil-producing regions," says Gary Thayer, senior economist with A.G. Edwards & Sons.
"If we were to see a lot of that taken off the market, that would be a real problem."
But given the importance of oil money to Russia and other parts of the former Soviet Union, "we think the probability of them allowing something to happen there is still pretty low," Thayer says. "They need the revenue from the oil."
A conflict in the Persian Gulf wouldn't create a crisis in the U.S. the way it did during the OPEC oil embargo of the early 1970s, says Henry R. Linden, director of the Energy and Power Center at the Illinois Institute of Technology.
"The world oil market is so efficient," he says, "every time one of these happens, the impact is less and less and less. The downward pressures [on the price of oil] are greater than the upward pressures over the next three to five years."
Crude Awakenings
Cheap oil takes a chunk out of oil companies' earnings.
It cuts costs for consumers and businesses, but today's low prices make it harder for the oil biz to fatten its bottom line.
Individual oil companies have no real control over the fluctuating price of oil, so a sustained period of cheaper-than-average oil cuts into revenues and margins. And low prices don't just affect the companies that must sell their products with smaller price tags.
Cheap oil also gouges companies that are involved in the exploration, production and refining of oil and those that offer drilling services and equipment.
Oil Stocks a Volatile Bunch
When oil prices started to slide in October from almost $23 per barrel of crude to around $15 in February, oil industry stocks plummeted right along with them.
Oil price fluctuation is one reason why oil stocks are a volatile bunch. So far this year, each oil sector trails the gains made by the S&P 500.
While the outlook for 1998 is generally gloomy, oil prices are up from their $13 low. The main fallout from low oil prices may be over and efficiency gains in the industry help minimize damage. Analysts say some sectors can still please investors even if oil prices don't rally.
In many cases, earnings will decline this year compared with 1997, according to Baseline Research. The hardest hit will be oil exploration and production companies. The integrated oil companies, which do everything from exploration to marketing, will also suffer. On average, the refining and marketing sector should post modest earnings gains. The best performance is expected to come from the drilling and services sector.
Good Well Hunting
Exploration and production companies are most directly affected by oil price changes, so it's no surprise that E&P-petro-lingo for exploration and production-stocks declined last year and are struggling to stay in positive territory in 1998.
Revenue for E&P companies is, in a general sense, price-multiplied by how much oil the companies produce. Lower prices mean less revenue and smaller margins, which goes almost straight to the bottom line. And less spending than planned by the major oil companies also shrinks revenue, says analyst William Featherstone at Schroder & Co.
"All the earnings will be down," says analyst Benjamin Rice at Brown Brothers Harriman. For the Baseline E&P group of 144 companies, earnings are expected to decline 46 percent. But wildcards like Iraqi production can tousle predictions.
Analysts recommend that investors should focus on E&P companies that have significant natural gas operations. Those companies are less vulnerable because pricing for natural gas is stronger. And after being tanked by El Ni¤o last year, demand for natural gas should be even higher than in 1997, says analyst Robert Christensen at Gerard Klauer Mattison.
Because almost half of natural gas goes to industrial activity, continued economic growth will also point to healthy demand and earnings growth for natural gas operations.
Big Oil - Lower Risk
Because the major oil and gas companies do a bit of everything, they're hit by cheap oil just like all the other sectors.
Oil prices cut Baseline's global integrated oil group of 26 companies to "only" a 22 percent gain last year and a solid, but S&P-trailing gain in 1998.
The integrated companies are being hit hardest in their exploration and production operations. Demand for refined products will increase, but it can't make up for the revenue lost because of cheap oil, says analyst Paul Ting at Salomon Smith Barney. Many have chemical businesses, which will also see little or no growth in 1988.
Because of the combined cheap oil-related problems, 1998 earnings are going to be lower than those in 1997. But after a weak first half, the sector should begin to strengthen.
The group has improved their operations and balance sheets in the past several years, too. "Major integrated oil companies are in the best financial shape ever," says analyst Fadel Gheit at Fahnestock & Co. As a result, they are better positioned to deal with cheap oil and should see significant improvements when oil prices rise again.
Drilling For Profits
Companies that provide drilling, equipment and services to major and independent oil companies were Wall Street's favorites before oil prices tanked.
Last year, the Baseline group of 95 companies still managed to rise 51 percent, compared with the S&P's 32 percent gain. Despite strong earnings projections and some merger activity, the group is up only slightly in 1998.
These companies contract out their services for periods ranging from weeks to years and earn what the major oil companies choose to spend. When the big players feel the pinch of cheap oil, they may trim their spending. The drilling, equipment and services group will feel some pain.
But spending in the sector should be a solid $90 billion-plus in 1998, says analyst Paul Chambers at Lehman Brothers. As a result, earnings growth should be strong-19 percent is expected for the group-in part because there have only been about $2 billion in budget cuts resulting from cheap oil prices.
The best performers in 1998 will be deepwater drillers and related equipment and services companies. Deepwater contracts are longer and their pricing has remained firm, says analyst James Van Alen at Janney Montgomery Scott.
The reservoirs are huge and potentially very profitable, which attracts the attention of the major oil companies. With deep pockets and long-term perspectives, the majors won't slash spending because of a pricing slump.
Gas Guzzler's Revenge
Cheap oil spoils companies and consumers alike. "Fuel economy isn't on their mind," says Wayne Satterwhite, sales manager at Haynes Jeep & Eagle in Richmond Virginia.
He says people shopping for the ever-popular, gas-thirsty sport utility vehicles aren't thinking about fuel efficiency, unlike auto buyers of the 1970s. "In the gas crunch in 1973 and '74," Satterwhite recalls, "then people were really fuel-efficient-minded to a fault. But now they've adjusted to the low gas prices."
The upside of months of low oil prices is economic growth, low inflation and cheaper fill-ups at the pump. But the downside, according to energy watchdogs, is that consumers forget the lessons of fuel efficiency and energy conservation. And companies too are relying on cheap energy instead of becoming more economical about energy use.
The 1970s and '80s energy crisis made people more aware of the consequences of energy use because of the pain it inflicted. With the temporary comfort of cheap oil, some of those considerations have been pushed aside.
Wallets Benefit, Not Greens
The impact of cheap oil is fast. Pressure on wallets that pushes people to use less energy or find cheaper and environmentally friendly energy sources has eased. Alternative energy sources, already suffering from weak demand, are even less popular.
Cheap oil means businesses can put off costly equipment changes because energy costs, which can make up a big part of the production bill, shrink themselves. All those factors can have a negative impact on the environment and energy efficiency efforts.
"If a commodity is cheap," says Joseph Minott, executive director of the Clean Air Council in Pennsylvania, "people tend to not think very carefully about how they are using it."
Cheaper fuel means more driving, especially on summer vacations. Bigger cars like sports-utility vehicles are more popular because they're less expensive to gas up. Consumers are also less likely to factor energy cost into appliance purchases and home heating decisions.
And cheap oil and gas also make it harder to get people talking about the benefits of conservation, Minott says, unlike when prices were much higher. "I remember during the Carter administration when we had those long lines at the gas pumps," he says, "we were always thinking about saving energy."
Americans Hitting the Road
More driving-it looks like a big summer for trips in the car combined with warm temperatures make for a poor pollution picture, says Linda Urata, executive director of Project Clean Air in the San Joaquin Valley in California.
Not only will carbon dioxide emissions increase, but nitrogen oxide emissions will go up too, creating more smog and ozone that can be kept close to the ground on hot days.
Business and industry are no better than consumers.
In the 1970s and 1980s, businesses were forced to become more energy-efficient to reduce their costs. As they cut their energy use and energy bills, they improved their bottom lines and became more competitive. Now, energy improvements have slowed, says Russell Sturm, executive director of the International Institute for Energy Conservation, and the economy is more dependent on energy.
Too Reliant on Energy?
"We're building an infrastructure on oil prices that are unsustainable," says Sturm. "It's a pretty vulnerable position to be in."
Countries like Germany with higher oil and other energy prices, Sturm says, have more energy-efficient economies. And they won't feel as much economic pain as the U.S. when oil prices go back up.
Low oil prices have made life easier for many Americans. And there has been great progress in energy efficiency and reducing environmental side-effects since the oil prices were this low decades ago.
Sports utes, for example, aren't the gas guzzlers of 1970s Detroit. But watchdogs urge that environmental and conservation considerations become a greater factor in people's decision-making, even before higher prices make it a necessity.
U.S. Quiz
How slick is your oil IQ. Slide Tru this quiz and find out.
1. What state uses the most petroleum per person
a. Alaska
b. California
c. New York
d. Texas
2. In what year did oil prices reac their peak this century
a. 1929
b. 1973
c. 1978
d. 1981
3. The United States consumes as muc petroleum as
a. Brazil
b. China
c. Germany
d. Brazil, China, Germany, Japan and Russia combined
4. The worlds largest oil tanker is as long as
a. Distance between Dallas & Houston
b. Four football fields
c. Height of the Empire State Building
d. Tad less than the love boat
5. In 1998, how much is U.S. oil demand expected to increase
a. 0.4%
b. 1.8%
c. 3.7%
d. 5.0%
6. What accounts for 1/2 of the 18.6 million barrels of oil the United States uses every day
a. Automobiles
b. Chemicals - plastics manufacturers
c. Farm equipment
d. Power Generation
7. About how of the oil Americans consume is imported
a. 10%
b. 25%
c. 50%
d. 75%
8. What country does United States import more oil from
a. Saudi Arabia
b. Canada
c. Iran
d. Venezuela |
