Oil price to cause a blow out?

Will the low oil price cause a blow out in the UK Oil and Gas hydraulics sector?

Deciding whether the fall in oil and gas prices will have business implications for hydraulics manufacturers.

The Oil and Gas hydraulics sector has undoubtedly been a strong growth area for some years. Some businesses have done very well indeed from high levels of investment. There have been big developments in new fields around the world along with the infrastructure and pipelines to get oil out. With high oil prices and an expectation of continuing high demand, there has been big investment in developing marginal oil and gas fields such as deep water drilling. The North American Shale gas and Tar sands production has required massive investment simply due to the sheer scale of the business. There has also been a need to upgrade and replace a lot of infrastructure after some years of use. Close to home, this is very true in the North Sea.

The drop in oil and gas prices has been quite dramatic the last six months, with oil falling from 127USD per barrel down to 70USD last week. Yes, there has been a low oil price before, but is there any difference this time round?

Commentators seem to suggest that although the demand for oil and gas is flat due to a sluggish world economy, the principal issue is an excess of supply. The US shale gas industry has dramatically changed the game, probably for the foreseeable future as the US will be self sufficient in due course.

Clearly with low prices, something has to give. The Economist magazine had interesting articles last week, both on the implications for shale gas producers and also OPEC. Commentators suggest that the OPEC policy of letting the low price run rather than cutting their own production, with the aim of forcing shale gas producers out of the market may well be pragmatic as the OPEC members are not all in a position to be able to cut production. Saudi Arabia has costs of only 7USD per barrel and reserves of 900 billion USD, so can sit things out. Other producers such as Venezuela will really feel the low price, but apparently have not toed the OPEC line when the cartel has decided on cuts in years gone by. The political fall-out from a low oil price for some producers may be quite dramatic. What could be the implications in Russia? There have also been articles in the newspaper this week flagging up the indebtedness of some of the state oil and gas companies of some major oil producers. The sums are staggering and totally unsustainable with the price of oil down at under 70USD.

The shale industry is also interesting. The Economist reckons that as of now, substantial costs are sunk and production costs are low, allowing producers to run on for twelve months or so before new investment is required. It is at this point that the business case for the investment would not stack up. That said, you have still got to service the debt which you took out when oil and gas was at a much higher price. Yes, there is likely to be a bust in the shale gas industry but because of the nature of the financing, things would bounce back again after a few years.  That is the nature of junk bonds and US business.

In the mean time, the majors have already cut investment in new production, with the knock on right down the chain to individual systems and components from the Oil and Gas hydraulics sector. This seems to have been happening for some months, although there will always be a lag. I would have thought it inevitable that some big orders that were “on the way” will be put on hold.

What might be of greater concern is the demand side of the oil market. For some months, commentators seemed to be noting that the world economy was sluggish, but they saw the excess supply as the principal reason for the drop in prices. In the last week or so, there seems to have been increased focus on demand and in particular the reduction in demand from China. This seems difficult to believe from an economy where everybody aspires to a Range Rover or Audi. On a more serious note, it may highlight a slowdown in industrial production, as oil is a raw material for an awful lot. We already know that mining companies have seen a substantial slow down in demand for raw materials along with all the associated issues.

Maybe the Oil and Gas hydraulics sector is in for a slowdown but equally important is that all may not be so well in the world economy should there be a slow down in China. That is probably the bigger risk for the Hydraulics industry as a whole.

There are clever people who are paid to ponder on these matters. Sarum Hydraulics (https://sarum-hydraulics.co.uk) just designs and manufactures our Micropac hydraulic pumps. If anybody has any views, send them over.