Sunday, 2 August 2015

Thoughts on Oil and Gas Companies (Part 2)

This is the second part of my thoughts on oil and gas companies. The first part of this can be found at: Thoughts on Oil and Gas Companies (Part 1). Here I'll be sharing some of my thoughts on oil prices, interest rates and some general factors that may affect the industry. (Not an expert on this industry but this is what I understand by reading online and asking Mr. Google)

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Oil Price
This is one key factor that would affect the profits of oil and gas companies in Singapore, especially since the two examples mentioned in the previous post, Ezra and Ezion, provide offshore services, which would be affected even more by the oil price as offshore oil production is expensive and the decrease in oil price below a certain price would make discovery and drilling of new wells unprofitable, decreasing the market for such offshore services.

I think that oil price is unlikely to increase back to previous levels for three reasons: grid parity of renewable energy sources, shale oil and the increasing efficiency of motor vehicles.

  1. Grid parity refers to the able of renewable energy sources to generate power for the same cost as using oil, natural gas or coal. With increasing efficiency of harnessing the different renewable energy sources, grid parity s possible is some areas without government subsidies. This reduces oil's popularity with grids as a means of generating energy, who may now turn to renewable sources, reducing demand for oil.
  2. Shale oil provides another supply of oil. While it is more expensive than offshore oil drilling, this would still place a "cap" on oil prices. Any increase past this point would attract the shale oil producers who will be able to make a profit selling at that price, pushing the price back to the "cap"
  3. The increasing efficiency of motor vehicles is another reduction of demand for oil. The introduction of electric vehicles which rely on electricity (whose dependence on oil is being reduced as mentioned in first point) and increasing efficiency of motor cars by 5 miles per gallon since more than a decade ago in the US reduce the demand of oil for use in motor vehicles.
These are some of the reasons that I think oil prices will not be able to increase back to previous highs, at least in the medium-term.

Interest Rates
While the interest rate doesn't seem likely to be increased in the short-term with the soft economic data in the US, however, as mentioned in How the Economic Machine Works video, interest rates are likely to rise when the market is doing better, which is mostly a matter of not if but when. When the interest rates start climbing, the companies which are facing relatively large amounts of debt will increase their finance expenses.

Investor sentiment on these shares
While the two above factors work against the oil and gas companies, the bearish investor sentiment on these shares has led to low share prices for them. Should market conditions improve, whether a decrease in interest rates (which seems unlikely since they already are quite low) or an increase in oil price (against the factors mentioned above, such as the case of an oil supply disruption or QE, which some people say has been linked to high oil prices), the companies would be able to give good returns to its investors when purchased at their current prices.

The oil and gas industry seems to be very cyclical, with the current decrease in oil prices being the down side of the cycle. However, I don't expect oil to be able to return to such high prices again in the short- to medium-term (not really sure on long-term future of oil). The decrease in oil prices will definitely take a toil on the profits of service providers such as Ezra and Ezion as the industry would not be able to pay top dollar should oil price remain depressed for a long time or even have to cancel upcoming projects.

But, balancing this likely reduction in the profits is the low share price. My views on investing in oil and gas companies is quite mixed and they may go either way. Maybe it's worthwhile putting a small percentage of our portfolio in it to reap the gains if it improves and limit our losses if it goes the other way?

P.S. GiraffeValue from has done a guest post on 55 Singapore finance bloggers, which highlights some must-read posts by the different bloggers as well as some info and quotes by them on Money Digest, which can be seen at 55 SG Financial Blogs that Actually Inspire You to Think Rich and Grow Rich. I think this post would be worth a read to see the different finance bloggers in Singapore :)

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