Be not afraid…

As the prices of benchmarks such as Brent and WTI remain very volatile (albeit with a bearish trend), we thought that we at Awbury should offer a few observations; not in terms of forecasting oil prices over the short term (all we know is that we would be wrong!), but in terms of trying to point out a few issues that any analyst should be taking into account in assessing the risks that arise from such an environment.

So, here goes.

– In a rational world, the dramatic fall in the price of crude oil should be an unalloyed good for economies that are net importers of oil- with India, Japan and Turkey being prime examples. Yet, in our inter-connected world, it is not quite as simple as that; because, while the lower cost of imported oil clearly benefits an importer’s balance of payments, the broader loss of confidence and lack of “petrodollars”, can reduce FDI and the appetite for assets or investments in jurisdictions seen as “more risky”. So, developed market importers seem likely to benefit more, at least in terms of perception
– It’s not just about the O&G industry. While the focus may be on the Supermajors and down the chain in terms of scale, many industries depend on “O&G” for a significant portion of their revenues, particularly in manufacturing, so one has to be aware of the risk of “collateral damage”
– The geopolitical ramifications are likely to be significant in the absence of a material rebound to significantly higher price levels. While Saudi Arabia (which we would characterize as a “brittle” regime) may be the low-cost producer, it has created an economic framework and clientelism structure that depend on oil prices being a multiple of what they currently are, so there is a potentially existential race going on to adjust, if possible, to a radically changed world, exacerbated by the mutual antipathy between Sunni and Shia Islam
– It seems likely that there is a new “world order” being established in the O&G business, with the US shale-based production segment becoming the swing producer. The OPEC cartel is notoriously dysfunctional; and it remains to be seen whether its members can work out a way in which to re-assert some control over pricing
– Desperate people do desperate things. Regimes whose “legitimacy” and survival are threatened by the current pricing environment are more likely to take actions that may seem helpful for them, but create further instability elsewhere. And, as we have seen, mere hints of “talk” can create significant volatility. Overt actions would be likely to have a much greater impact
– Lower oil and gas prices can depress investment in “alternative energy”, and thus have an impact on the calculus of climate change
– The scale of the price decline has created dislocations in the High Yield bond markets, as investors anticipate a rapid acceleration in bankruptcies of an ever broader range of businesses, who simply do not have the ability to adapt without shedding most of their existing financial liabilities
– History tends to teach that prices can rise just as rapidly as they have declined because of some, as yet, unforeseen catalyst. As we said at the start, if we were to try to forecast the price of crude oil, we would be almost certainly wrong!

Yet, in spite of all the above, the world’s economy will eventually adapt, even if some of the changes and outcomes will be material, and perhaps unwelcome for some.

So, at Awbury, are we wary and cautious? Of course. Are we afraid? Most certainly not! Challenges and dislocations bring opportunity, as well as threats.

The Awbury Team


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