Are Oil & Gas-Related Companies Dead With Tumbling Oil Prices?

Oil & gas-related companies have not had a great time these past two months. Ezion (SGX: 5ME) has fallen by 19% since the start of September. Within the same time frame, Ezra Holdings Limited (SGX: 5DN) and Swiber Holdings Limited (SGX: AK3) have slid by 29% and 22% respectively. Even the large-cap oil & gas-related shares have not been spared either with Keppel Corporation Limited (SGX: BN4) having fallen by 11% in that period.

In contrast, Singapore’s market barometer, the Straits Times Index (SGX: ^STI). has slipped by less than 3% to its current level of 3,224 points.

All told, close to S$3 billion worth of equity have been wiped out from these few companies in less than 60 days. What is happening?

Oil price

The short answer is that oil prices have been dropping for a few months now. The price of West Texas Intermediate (WTI) crude oil has fallen from more than US$100 per barrel in July to only a shade higher than US$80 per barrel currently, even going so far as to dip below US$80 per barrel last week before rebounding. A short term drop in oil price might not be a major concern for these oil & gas support services companies, but there might be a bigger problem that lies beneath.

The US oil industry is experiencing a shale oil renaissance with many domestic companies perfecting their horizontal drilling techniques which are used to drill through shale rocks to extract oil. In fact, the US is planning to become totally energy independent in the near future and the International Energy Agency actually predicts that the US would become the world’s largest oil producer by 2015. With the US gushing oil and other oil producing countries potentially losing their largest customer (The US), the global oil environment is undergoing a serious restructuring.

However, there is a catch: The cost of producing shale oil is not cheap. Estimates on the cost of production in the Bakken Formation, one of the most actively drilled areas in the US, ranges between US$58 to US$70 per barrel.

Meanwhile, the cost of oil production for many of the OPEC (Organisation of the Petroleum Exporting Countries) members are much lower; it is estimated that production costs in Saudi Arabia, the largest oil producer in the world currently, can be as low as US$1 to US$2 per barrel. If the OPEC feels threatened by US shale production, there is a real chance that they might flood the market with oil to push the price of the fuel below the cost of production for the US producers.

If that happens, there is a real chance that the price of oil will stay low for a long time to come as the OPEC tries to drive the American players out of business.

So what?

Now this is where it links back to the oil & gas-related companies in Singapore. Low oil prices matter to them because capital expenditures in the oil & gas sector is driven by the price of oil. As the price of oil slumps, capital expenditures in the industry might slowdown as well.

Since a majority of the oil & gas-related companies listed in Singapore are providing support services or helping to build the rigs and vessels used, lower capital expenditures across the board would mean lower revenue for all of them in the future.

Foolish Takeaway

If (and this is a big if) this is the beginning of the end of the oil cycle, then we should be really concerned with the prospects of these companies in the future. Crucially, those which have expanded rapidly through the heavy use of debt might be the most vulnerable if the oil & gas support services industry does slow down significantly.

Be prepared.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim owns Keppel Corporation.