Since OPEC – the Organisation for Petroleum Exporting Countries – decided not to prop up oil prices by cutting production levels last week, everything has gone pear-shaped.
Indeed, just three months ago prices of $US90 per barrel for WTI crude were considered good, but now at $US66.81 a barrel, investors don't know what the fair price of oil is. Some commentators are suggesting it could drop to $US50 per barrel, whilst others think we've already hit a bottom.
Wherever the price ends up, Australian investors will be feeling the pain of uncertainty. The burning question is who's getting hurt most from these ultra-low prices?
Russia is suffering a massive drop in foreign investment (it also has Western sanctions against it following its involvement in the Ukraine), the Ruble is falling hard and its economy is slipping into recession.
Saudi Arabia is an exceptionally low-cost producer with a huge amount of foreign currency reserves (estimated at $US800 billion). So it may be prepared to ride out lower prices for longer. Although smaller, higher-cost, producing peers included in OPEC are unlikely to be breaking even at today's prices.
Daniel Yergin, vice chairman of IHS Inc, believes around 80% of the United States' shale oil producers need prices of between $US50 and $US70 per barrel to breakeven in 2015. Given the current pricing environment, they too could come under significant pressure and be forced to put off expansion projects.
Closer to home, shares in ASX-listed oil and gas producers Woodside Petroleum Limited (ASX: WPL), Santos Ltd (ASX: STO) and Oil Search Limited (ASX: OSH) have been hit hard, despite their proximity to Asia and relatively low costs.
Woodside reported a total production cost of $US25/boe in its most recent half-year results presentation.
Source: Google Finance
However there are a number of ways to profit from lower oil prices, they are undoubtedly good for some companies, such as airlines. Qantas Airways Limited's (ASX: QAN) fuel costs were a record $4.5 billion in FY14, accounting for some 28.5% of the company's total expenses.
Buy, Hold or Sell?
Falling oil prices could hurt Australia's oil and gas stocks in the near-term as the market finds its equilibrium. It will result in lower revenues, profits and capital expenditure. So if you are going to pick up some oil stocks, focus on the low-cost producers which have projects set to last for many years. As for Qantas, I'm sceptical these price falls will solve all its issues and return it to profitability in the near future.
