‘Lower for Longer’; Is 2016’s Oil Crisis Going to Transform Energy Markets Permanently?

offshore rig

The main drivers have been cited as being cost deflation and OPEC policy along with the effects of shale oil and gas. We spoke to James Sinclair at Trade Finance Global, who believes that gas and oil demand will continue to increase, even as renewables continue to grow strongly.

At the recent World Petroleum Congress, it was concluded that the continuing investment in oil and gas is required to cater for demand growth and to compensate decline in mature fields.

We are coming into an era of price volatility. There is a need for oil prices to recover and to enable the higher cost of supply, but lasting cost deflation is key for the new long term ‘equilibrium’ of the oil price.

We are seeing that more and more companies are focusing on cost reduction, maintaining of balance sheets and assessing the grading of portfolios for fund managers.

Low oil prices are weighing on the industry, but it is estimated that 2015 was a record year with oil and gas loan volumes of USD 125 billion. There was a strong refinancing market for larger commodity traders and oil and gas majors. Oil and gas volumes are mainly driven by deals signed in the upstream sector as they were in 2015.

Northern European volumes continue to dominate due to strong activity in the North Sea. There has been a collapse of Russia volumes due to sanctions and geo-political reasons.

Commentators have also seen that African volumes have also dropped off as banks have pulled away from foreign markets.

We are starting to get into an interesting part in the commodities cycle as various borrowers have previously benefitted from past hedges; receiving floors between USD 60 and 70 – but these hedges are starting to run out.

Credit facilities have dried up and for those reserve based facilities, there is reduced debt availability as the underlying value of the assets has reduced. There are also potential breaches of covenants due to the leverage ratio.

The different cover ratios applied to asset valuations have limited the impact of falling oil prices and sometimes amendments or restructuring is required.

The Macro View – What is happening in the energy markets?

The phrase has been coined by an industry veteran – Bob Dudley, ‘Lower for longer’, and we question – is this really the case?

  • Many predict that we should see a rebalancing of supply and demand in the summer
  • There are supply disruptions with countries such as Iraq and Kurdistan
  • US Shale – last year this was a hot topic
  • Price inflection – Oil supply falls in the summer and is at over 600,000 barrels a day
  • The market is starting to correct, but stocks will remain high this year and going forward
  • Forward markets have seen significant strength

Conclusion
Oil and gas markets continue to remain incredibly challenging, and given the recent strategic shift away from oil in Saudi Arabia, and the continued lows for oil price, we wait in anticipation to see what’s in store, and how the oil players react to this extraordinary change.