Saturday, November 7, 2015

Casey Daily Dispatch: Shock, Denial, and Panic in the Oil Sector

This article from Casey Research touches on the impact that much lower oil prices are having in the US and around the world. Since I have worked in the oil industry for over 35 years (in accounting) I have degree of understanding about how this industry works and impacts society. Below are some quotes from this article and then a few added comments.

Investment firm Oppenheimer (OPY) said this in a recent note. The folks there must agree with us…there’s more pain ahead for the oil patch. As we’re about to explain, anyone who’s buying into the oil sector right now is getting in too early.
•  Oil giant BP plc’s (BP) quarterly sales fell 41% from last year…
The company shared the bad news yesterday. It was the third quarter in a row that BP’s sales fell by at least 35% from the previous year.
BP’s sales are down because the price of oil has collapsed. Oil peaked at just over $106 a barrel last summer. Today, it’s trading for around $46.
•  BP expects oil prices to stay low for at least another year…
That’s what the company’s CEO, Robert W. Dudley, said during yesterday’s earnings call. The New York Times reports:
In its announcement on Tuesday, the company said it was basing its outlook through 2017 on oil prices of $60 a barrel.
In a call with analysts, Mr. Dudley backed up this view with a slide showing that the futures market was now forecasting oil prices of $60 to $70 per barrel into the 2020s. That is a large drop from earlier this year, when the projections were for about $70 per barrel in 2017 and about $80 by 2021.
BP has stopped all of its exploration and development projects for now. The company expects to spend just $19 billion on capital projects this year, or $5-7 billion less than it had projected before the price of oil plummeted.
To cope with low oil prices, BP also plans to lay off 4,000 workers (about 5% of its workforce) by the end of the year. It has sold nearly $10 billion in assets this year, and it plans to sell another $3-$5 billion in assets next year.
. . . . . 
•  The oil crisis could spread outside the energy sector soon...
Energy spending has been a major driver of U.S. economic growth since the 2008 financial crisis.
The Carlyle Group (CG), one of the world’s largest private equity firms, recently explained just how important energy spending is to the U.S. economy:
Between 2009 and 2014, energy accounted for an astounding 70% of net industrial fixed investment in the U.S., as investment in unconventional oil and gas boomed at the same time business investment in the rest of the economy barely kept pace with depreciation...
In the 1990s, the U.S. invested about half as much in oil and gas rigs as in manufacturing plants; between 2008 and 2014, the situation had reversed, with total U.S. investment in oil and gas rigs 3x larger than investment in manufacturing facilities.
Orders for durable goods (the equipment and machines that companies don’t replace often) fell for the second straight month in September. On Tuesday, Reuters said spending cuts by energy firms were a major reason for the decline.
My added comments: The oil and gas industry has its share of critics and some who would like to see it fall by the wayside. I certainly understand that the industry deserves some of the criticism it gets from time to time as no industry does everything right and most of us want to see the world continue to develop new energy sources that are clean, affordable, and meet the needs of society.
I will say that in my view the best way forward is for oil prices to stay high enough to support the industry as the slow and steady change over to newer energy sources takes place. The world cannot run without fossil fuels for a long time yet into the future. There simply aren't enough alternative sources yet that are abundant enough to carry the load at affordable prices for the average person. But things are moving in the right direction as we a steady increase in the use of alternative energy sources. Oil prices that are too low actually discourages this transformation because it will lower demand for alternative energy sources and boost demand for fossil fuel energy sources. Oil prices that stay in a $65 to $90 range can work well to support the industry and allow for the change to alternative energy to move forward while keeping energy affordable for most people in my view.
One thing I will add. No matter how you feel about the oil and gas industry it has been a major financial contributor to society. Not only in providing affordable energy for the average person, but also in the huge amount of taxes and royalties it pays out across the board in society. Here is a list of just some of those that energy companies pay:
- royalties to the US government and state and local governments (usually 12 to 18% of gross sales) 
- royalties to private land owners in numbering in the millions of people (some elderly heavily depend on these royalties as a main source of income along with social security). In Alaska, everyone in the state gets a royalty.
- production/excise taxes to state and local governments (31 states have some form of production tax on oil and gas)
- sales taxes on equipment purchased to state and local governments
- school taxes to many school districts across the country
- income taxes on profits earned
- property taxes on land, buildings, etc. to state and local governments and school districts
- charitable giving - many industry companies are also leaders in charitable giving in local communities along with their employees
- dividends to shareholders for companies that have public stock (most pension funds, retirement funds, etc own some stock in energy industry companies)
- here is an article that kind of summarizes the above. All combined the energy industry has paid many trillions in various forms of taxes and royalties over the last few decades. Some argue they should be paying more, but no one can dispute what has been paid out and that tens of millions of average people do benefit from all this.
Please keep in mind that all of the above stakeholders (numbering in the hundreds of millions of people) are hurt by oil prices if they get too low. This is in addition to the hundreds of thousands of people employed directly or indirectly in the industry (who also pay many of the above taxes out of their salaries). Lost tax revenues on all the above listed taxes have to be made up from the general public to maintain public services so virtually everyone benefits from the taxes paid by the energy industry.
I hope we see prices stay high enough to support the industry and the above stakeholders and low enough to keep energy affordable for most people as we move towards the increased use of alternative energy sources in the future.
Added note: Here is a related article that may be of interest - State of the EU Energy Union

Additional added note: Here is another related article that may be of interest.

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