What’s happened: The oil crisis has taken its toll on U.S. energy companies with Fairfax media reporting that a large number of drilling rigs had been shut down last week with many projects having been rendered unprofitable.
Why it’s happened: Oil prices have more than halved over the last seven months as a result of waning global demand, a supply surge from the United States and the refusal by the Organisation of Petroleum Exporting Countries (OPEC) to reduce its lofty daily production target.
Given the speed at which the oil price has plummeted, it was only a matter of time before some producers began to buckle under pressure. While OPEC has made it clear that it will not reduce its production volumes, it has also stated it is content with lower prices for as long as need be based on the notion that many U.S. producers will not be able to operate profitably at these lower levels (as shale oil is currently more expensive to produce than conventional oil).
The oil price surged 5% on Friday after the International Energy Agency reduced its supply forecasts from non-OPEC producers, including the United States, Canada and Russia. As highlighted by The Australian Financial Review, energy investment bank Tudor Pickering Holt has forecast 400 rig closures in the first quarter of this year, while it expects 800 by the end of 2015. One associate from the bank said: “Crude prices have tanked and we view the US as causing the oversupply, so the US needs to fix it.”
Indeed, while the closure of those rigs could hurt the economy, it would certainly provide some relief to the commodity’s depressed price. Higher prices would also come as a relief for companies such as BHP Billiton Limited (ASX: BHP), Oil Search Limited (ASX: OSH) and Woodside Petroleum Limited (ASX: WPL), from which billions of dollars have been wiped from their value collectively over the last several months.
What will happen next: Of course, investors need to remember that the relationship between rigs and production is not equal. It’s likely that when producers close some of their higher cost mines, they will avert their attention towards their lower cost operations until prices recover. As the AFR pointed out, it’s also possible that we could see acquisition activity in this low-price environment, when some of the industry’s bigger players take advantage of depressed valuations.
However, investors shouldn’t get too carried away just yet. Despite these closures, there is a very big chance oil prices could continue to fall in the short-to-medium terms, which could see stocks in the energy sector plummet even further. Until then, there are far better ways to play the resources sector.
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