Royal Dutch Shell Plc  .com Rotating Header Image

Reuters: Big oil’s rally run threatened by recession

Tue Jan 22, 2008 6:26pm EST 
By Michael Erman – Analysis

NEW YORK (Reuters) – The oil industry is expected to be one of the losers if fears of a U.S. recession become reality this year, as falling oil prices take the steam out of the sector’s four-year boom.

Worries of a recession sparked sell-offs in financial markets around the world this week, and the U.S. Federal Reserve slashed a key interest rate by three-quarters of a percentage point on Tuesday in order to quell those fears.

A recession could cut into energy usage and slow demand around the world, and would likely halt the upward march of oil prices, which briefly hit $100 a barrel earlier this month on tight supplies, geopolitical risks and the weak dollar.

“We thought that we had seen a peak in earnings a few quarters ago,” said Lewis Ropp, energy analyst with investment firm Barrow, Hanley, Mewhinney & Strauss Inc, because it seemed commodity prices were near their peak but the costs of producing oil and gas were still rising.

“We also had a situation where refining margins and upstream margins peaked simultaneously and you don’t often get that,” said Ropp. “From here we would expect that there would be some downward earnings revisions and probably the stocks will reflect those.”

Analysts and investors said big integrated oil companies like Exxon Mobil Corp (XOM.N: Quote, Profile, Research), Royal Dutch Shell (RDSa.L: Quote, Profile, Research), BP Plc (BP.L: Quote, Profile, Research) and Chevron Corp (CVX.N: Quote, Profile, Research) would be able to weather a recession better than independent oil companies, which focus on oil exploration and production, because those companies have more direct exposure to commodity prices.

Independent oil companies include Anadarko Petroleum Corp (APC.N: Quote, Profile, Research), Apache Corp (APA.N: Quote, Profile, Research) and Devon Energy (DVN.N: Quote, Profile, Research).

The diversified nature of the integrated companies, which have refining as well as exploration and production operations, plus international exposure, should help cushion the fall, these experts said.

Shares of oil companies have already taken a hit this year. The Chicago Board Options Exchange’s oil index .OIX, which tracks the biggest international oil majors and independent oil companies, is down more than 16 percent from its all-time high on January 3.

HOW LOW WILL IT GO?

Crude oil prices have already retreated around 10 percent from peak levels, closing at a one month low of $89.85 a barrel on Tuesday.

Benchmark Co analyst Mark Gilman said the depth of oil’s drop in the event of a recession depends on how closely energy markets track fundamentals.

“Fundamentally there is every reason to believe that they are cyclical,” said Gilman. “Demand is directly proportional to the level of economic activity.”

But Gilman and others said recent crude oil prices have not always followed the fundamentals, so it is difficult to guess the size of a potential falloff.

“We frankly expected to see more of a correction in the second half of 2007 because of weaker demand,” said Barrow, Hanley’s Ropp. “I think there’s a certain amount of speculation and a certain amount of geopolitical risk premium that is slower to come out of the price.”

Even in the event of a recession, spending on exploration and production projects should stay robust, as long as oil prices stay above $60 a barrel, said Neill Morton, oil analyst at MF Global in London.

Morton said oil sands projects would be the first projects pared down if oil dropped sharply, because mining and processing the sands to make usable fuel is very expensive. They require oil prices of around $60 to be profitable, he said.

Gilman said the large share buyback programs that helped pump up the stocks’ values would be the first to go.

He said that oil majors’ capital spending programs often leave little room for companies to pare back spending as big projects require long lead times and steady investment.

“Excess cash flow is going to go down as a result of the weaker price environment and something has to give. I think its going to be share repurchases,” Gilman said.

(Additional reporting by Tom Bergin in London and Anna Driver in Houston; Editing by Tim Dobbyn)

© Reuters 2008 All rights reserved

royaldutchshellplc.com and its sister websites royaldutchshellgroup.com, shellenergy.website, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net and shell2004.com are all owned by John Donovan. There is also a Wikipedia article.

0 Comments on “Reuters: Big oil’s rally run threatened by recession”

Leave a Comment

%d bloggers like this: