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Oil Price Slide and Seek

Is it a sinister conspiracy? Is it a clever OPEC power-play? Or is it, as former US President Bill Clinton once remarked: “The economy, stupid”?

There is certainly no shortage of opinions about why the price of crude oil has fallen so much, so quickly. It wasn’t that long ago when the price of black gold was knocking on the doors of $120 a barrel. Today it is only about half that.

The here and now

This is where we are at now. It is also where we could remain while supply outstrips demand. That is because even if it might be unpalatable for some producers to continue delivering oil at current prices, they don’t have a choice. They still have bills to pay and budgets to balance. As far as oil producers are concerned return on equity is less important than return at any cost, right now.

Whilst the causes of the oil-price drop might be up for debate, the consequences are not. Oil affects almost every business, every country and everyone. The question is whether the fall is a blessing or a curse.

A timely reminder

For some, the fall in crude prices should be a timely reminder that ever-increasing oil revenues should never be assumed. Those that should take note include the myriad of oil producers that include KrisEnergy (SGX: SK3) and Interra Resources (SGX: 5GI).

Whilst not every oil explorer will necessarily fail as a result of low oil prices, the same cannot be said of cash-strapped oil drillers. Integrated oil majors are less likely to be affected though, especially if they have both upstream and significant downstream operations.

Oil services companies are often seen as a tangential play on the oil sector. These include Ezion Holdings (SGX: 5ME), Keppel Corporation (SGX: BN4) and Sembcorp Marine (SGX: S51). These “picks-and-shovels” companies should, in theory, make money regardless of whether a driller finds oil.

However, low oil prices could force oil companies to scale back on exploration. Some producers could even mothball their more costly oil fields to conserve cash, which could in turn reduce demand for rigs, drills and pumps. Again, cash is likely to be king. So oil-services companies with strong balance sheets could be some of the best positioned to weather the cycle.

Banking on oil

Banks, strictly speaking, are not directly exposed to oil prices. But they could have lent to both oil producers and to oil exporting countries. The level of exposure is not easily quantifiable, though. But be prepared if banks are forced to make provisions for bad and doubtful debts.

There is something else to consider. Cash rich oil exporters that include Bahrain, Kuwait and United Arab Emirates are the fifth-largest holders of US debt. A drop in oil revenues could see them reduce their appetite for US Treasuries, which could depress bond prices and push up US interest rates, earlier than perhaps Fed boss Janet Yellen may have liked.

Winners and losers

Anyone who is not a loser is likely to be a winner from the oil-price shock. Airlines, such as Singapore Airlines (SGX: C6L) and Tiger Airways (SGX: J7X) for example, are voracious oil consumers. The cost of aviation fuel can account for as much as half of total operating costs. So airlines could benefit immediately from lower oil prices, especially if they don’t pass on cost savings to passengers.

Elsewhere, haulage companies, logistics firms and taxi operators such as ComfortDelGro (SGX: C52) could also gain from lower fuel costs. Consumers could profit too. The cut in oil prices has effectively transferred money from the pockets of producers to the wallets of householders. Consequently, increased disposable income could eventually spark a consumer spending spree.

Cloud on the horizon

There is, however, a possible cloud on the horizon. Big governments could use the drop in oil price to raise fuel levies.

On the one hand that could help curtail the extravagant use of oil, which could help cut greenhouse gases. Higher fuel levies could also be a godsend for heavily-indebted countries. But the downside is a delay to the global economic recovery or, worse still, snuff out the nascent recovery altogether.

In the short term, a shakeout in the oil sector could see unviable businesses being driven out by lower prices. There is nothing quite like a price war to sort the weak from the strong.

However, over the long term prices could rise again, as supply is brought back in line with demand. That could benefit those who are financially strong enough to stay the course.

A version of this article first appeared in the Independent on Sunday.

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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 Director David Kuo doesn’t own shares in any companies mentioned.