It has been another bad year for the performance of natural resources stocks. Many commodity prices peaked in 2011, as China began to pull back from a surge in infrastructure investment that it undertook in response to the collapse of the global economy in 2008/09.
Beijing’s spending drove demand for construction, which in turn led to huge investment in steel, mining and cement facilities, itself boosting commodity demand.
With the benefit of hindsight, 2011 marked the peak of the ‘commodities supercycle’. Oil was one of the last commodities to be hit by price weakness, as demand in China is much less significant for oil than for most other commodities.
Oil price
The downturn in oil only started in the summer of 2014, as US shale oil production began to ramp up to become an influence on the supply-demand balance.
Brent crude fell from $115 a barrel to less than $50 in the second half of 2014. In 2015, there has been some stability at these lower levels.
The supply of oil has so far been very slow to adjust. Saudi Arabia seems to have taken a strategic decision not to cut production but instead to force higher-cost producers to close down capacity – these higher-cost producers are the US shale oil companies, where all-in costs of production are estimated at around $65 per barrel.
However, at the start of 2015, these producers, needing cash desperately, were able to raise significant new monies, both equity and debt finance, from US investors who apparently felt that the oil price was suffering from a temporary lack of demand and would soon move back up to much higher levels, so that the shale oil companies would once again be very profitable.
This recapitalisation has meant they will be slow to close down capacity and the oil price will be lower for longer.
This sentiment has been reinforced by Royal Dutch Shell’s bid for BG Group, an acquisition that only makes financial sense if the long-term oil price is much higher than current levels.
The hostilities in Syria have put many oil-producing countries on opposing sides of the conflict, making it more likely that they will all seek to maximise their oil production and less likely that they will trust each other to restrain production in an effort to boost oil revenues for all.
While oil supply will therefore remain plentiful – any rise in demand will require an uptick in the global economy.
Sadly, forecasts for global economic growth this year are being steadily downgraded, particularly with regard to the more oil-intensive areas of the world economy, such as global trade and manufacturing.
For the oil companies, earnings and cashflows have collapsed, and at the current oil price their dividends are substantially uncovered, even for the very best of them – and their share prices have fallen to reflect this.
However, the majors – Royal Dutch, BP and Exxon Mobil – have all pledged to maintain dividends in 2015 and 2016, and are cutting expense and investment spending in the hope that the cash saved will permit payments.
