Lessons to Learn as Oil Prices Drift Toward $20 a Barrel

Crude Oil


Weeks ago, oil priced at less than $50 a barrel was unimaginable. Today, a price of $20 draws the same immense skepticism. However, there are some justifications for oil prices to fall another 50%.The first case for oil dropping into the $20s is the direction in which some smart money is betting.

Crude oil hit a milestone on Monday [ January 5, 2015] by selling briefly under the $50 per barrel mark. That means that oil in the $40s has arrived. Whether this remains in place is up to the oil market gods, but it has serious implications for consumers and companies alike.

William Watts, writing at MarketWatch about oil expert Stephen Schork, said Here’s where it gets interesting: Open interest on $30 puts on the March futures contract CLH5, -2.61% rose to 2,127 from 34, while $30 puts on the June contract CLM5, -2.31% rose from 35 to 51,252. In addition, there has even been some light trading in June $20 puts, with open interest at 176 as of Friday’s close.

The beliefs behind the trades are likely based on the same reasons for the recent collapse of oil prices. Supply is plentiful. The economies (and almost certainly the demand) of Japan and Europe have stalled again. The Saudis show no sign of blinking in a supply war against U.S. frackers.


Oil-rich countries, including Russia and Venezuela, continue to produce and ship oil because they need the money. Even if producers in these countries (and the governments) are losing money, better to have some flow of revenue than no revenue at all.

Another critical theory about future oil prices is that the largest oil companies will not drop production sharply. They need to support production infrastructures that have cost tens of billions of dollars to establish. However, while these companies have the balance sheets to keep pumping, those same balance sheets allow them to idle some wells, taking them out of production. So, the big oil theory has only modest support as a means to pressure oil prices lower.

It will not take much in terms of news about sharp increases in supply from major producers, or evidence of sharply sliding demand, to almost certainly push oil prices closer to $40. Some smart money believes the price will go much lower. Smart money that bet on the recent sell-off did very well.

Crude oil hit a milestone on Monday [ January 5, 2015]  by selling briefly under the $50 per barrel mark. That means that oil in the $40s has arrived. Whether this remains in place is up to the oil market gods, but it has serious implications for consumers and companies alike. The intraday price was shown at a low of $49.95 for an on-the-run barrel of West Texas Intermediate (WTI) on Monday. What this means is far more important, particularly considering that oil has not traded under $50 since April of 2009.

Headlines hit on Monday that Saudi Arabia had lowered the price it was charging for light-sweet oil in the United States. It appears that Saudi Aramco lowered its light oil prices for February delivery by 60 cents per barrel. At the same time, Saudi Aramco raised light oil prices in Asia by the same 60 cents.

UBS has previously said that the boost to gross domestic product is now only 0.1% per $10 drop in the United States. That figure used to be a gain of 0.2% to 0.3% prior to the shale boom.

Deutsche Bank also had a figure that used to be used — that is that every $0.01 change in the price of gasoline at the pump is worth roughly $1 billion to the economy. So, imagine the cost per gallon north of $4 suddenly heading to (or even under) $2 per gallon.

Lessons Oil Companies Could Learn From Mining Companies

Open pit Copper mine at Lumwana in Zambia

Open pit Copper mine at Lumwana in Zambia

Since the beginning of 2011, some of the world’s largest mining companies have lost a third to nearly 90% of their market value as global demand for their products declined. In the same period, some of the world’s largest privately held oil companies have posted gains ranging from around 17% to about 26%.

If we had stopped the oil chart on July 24, oil company share price gains would have swelled to between 40% and nearly 66%. At no time since 2011 did the mining companies fall as far or as fast as oil companies have in the past four months.

Since early 2011, the price of iron ore pellets has dropped from nearly $220 per metric ton to less than $120, the same price that pellets sold for in 2009. That price swing has cost Vale S.A. (NYSE: VALE), BHP Billiton PLC (NYSE: BHP) and Rio Tinto PLC (NYSE: RIO) share price declines of 77%, 45% and 36%, respectively.

In a report titled “Mine 2011: The Game Has Changed,” the consulting firm PricewaterhouseCoopers said: To keep up with demand, the Top 40 [mining companies] have announced more than $300 billion of capital programs with over $120 billion planned for 2011, more than double the total 2010 spend. While not all will be completed, the sheer size and volume of the announced capital projects demonstrates an industry where fulfilling seemingly insatiable demand is the top priority.

Three firms — Vale, BHP and Rio — accounted for 50% of the total market cap of the top 40 mining firms, and total assets for the top 40 firms amounted to nearly $1 trillion. Mergers and acquisitions in the mining sector were just beginning to heat up, culminating in the February 2012 $41 billion acquisition of Xstrata by Glencore.  And then the music stopped.

Growth in emerging markets slowed sharply and mining companies, as the industry had done in the past, had already committed to large projects that took billions to develop and years to bring to completion. By early 2013, mining company mergers and acquisitions over the past 10 years had totaled more than $1 trillion. Write-downs taken in 2012 had cost shareholders about $50 billion in value and they revolted.

Rio Tinto wrote down $14 billion assets in 2013 and the CEO was fired. Gold miner Anglo American wrote down $4 billion and fired its CEO. BHP Billiton wrote down $3.3 billion in August 2012 on natural gas and aluminum projects, and Vale took a $4.2 billion charge in 2012.

The oil and gas business is doing all it can to avoid overstretching. Since late July, the share price for Exxon Mobil Corp. (NYSE: XOM) has dropped about 11%, while Chevron Corp. (NYSE: CVX) and Royal Dutch Shell PLC (NYSE: RDS-A) have both lost nearly 20%. BP PLC (NYSE: BP) is down 23%. The suddenness and degree of the crude price decline and the collapse of stock prices happened far more quickly than the decline in mining, but the oil companies appear to have learned some things from the mining company disasters:

·         Don’t wait too long to cut costs

·         Don’t wait too long to shed assets

·         Don’t make shareholders (and boards of directors) mad

·         Don’t expect miracles

SOURCE: Wall Street Journal (Without the Graphics)