With West Texas Intermediate Crude at US$22.59 (at the time of writing), oil prices are at their lowest point since the oil crisis of 1998. At that time, uncoordinated overproduction was at the heart of the issue. Today it is a little more complex.
Causes of record low oil price
On one hand, the price war between Saudi Arabia and Russia has created the oversupply required to drop prices. On the other hand is the coronavirus. Social distancing, lock downs, travel embargoes and shuttered industries have driven oil demand off a cliff.
The falling dominoes
The impacts are very widespread. The impact to sovereign oil companies means a reduction in national revenues. This hits countries like Iraq, coronavirus-ravaged Iran, Kuwait and Venezuela. The political fallout from that is yet to be felt.
In private industry, the impact spreads like shattering glass. The virus induced credit crunch restricts access to debt refinancing, therefore oil companies will have to reduce costs or sell assets. This means delayed capital projects and layoffs in some of the world’s largest companies.
At today’s price, crude is cheaper than shale oil. This will devastate the shale oil industry in the USA. In Asia, LNG is priced based on the crude oil price whereas in Europe it is generally tied to alternative sources of gas. Another raft of industries under pressure from the low oil price.
The low oil price challenge
This is the reality of investing in commodity producers. When demand is near an all time low, cost cutting is the only defence. This will challenge many S&P/ASX 200 Index (ASX: XJO) energy sector companies. Already, most capital expansions touted in the H1 earnings reports are on the block.
Santos Ltd (ASX: STO) is targeting a free cash breakeven price of US$25 barrel of oil (boe) from its present US$29 boe. Origin Energy Ltd (ASX: ORG) targeted a breakeven of <US$24 boe in its H1 earnings report.
Woodside Petroleum (ASX: WPL) is still hoping to make a decision on its large scale Scarborough project later this year.
Oil Search Limited (ASX: OSH) has already cut its capital expenditure by 40%, yet it remains exposed due to its net debt of $2.9 billion. In addition, its plans to refinance $300 million of debt by September is very ambitious in the current credit squeeze. At present, the company has a free cash breakeven point of $32 boe.
Low oil prices are likely to mean a level of cost cutting or selling of world class assets that many ASX 200 companies have not yet contemplated.
Oil Search in particular is facing a fight for survival. In the current situation, it is not clear that they have a path out of this without at least significantly changing the company.
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As of 17/3/2020
Motley Fool contributor Daryl Mather has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.