On Thursday, the price of a barrel of Brent Crude topped $50 for the first time since November, briefly reaching $50.22 before dropping back a little. As I write today, the price stands at $48.86. The breakthrough continues a trend that’s been going since January, when oil dipped below $28 per barrel.
But before we get too excited about any long-term price gains, the short-term reasons suggest caution is still needed. The fires raging across parts of Canada cut oil supplies by around a million barrels a day, and militant attacks in Nigeria have seriously damaged that country’s production capacity. The net result has been a 4.1m barrel fall in US inventories by the end of last week — though to put that into perspective, there’s still a stockpile of 537m barrels there.
Production cuts
There’s a growing consensus that production needs to be cut to get prices back to sustainably profitable levels, with OPEC, Russia, and others trying to bring about at least a freeze. And consumption has been strengthening, with even Chinese demand coming in ahead of bearish expectations.
A rising oil price will boost confidence in the 7.4% dividend yields expected from BP this year and next.The company has insisted it will keep them going, though that’s not a promise that can be open-ended. The same goes for Royal Dutch Shell, where analysts are forecasting a 7.5% yield. Shell hasn’t made any commitments, but I doubt it will want to cut its dividend while BP doesn’t.
Share price responses of the big two to recovering oil prices have been fairly muted, with BP shares up only 5% to 363p so far in 2016, though Shell shares are up 10% to 1,692p.
Too little, too late
At the other end of the scale, $50 oil could come too late for some. Gulf Keystone Petroleum springs to mind, as the ill-fated producer based in the Kurdistan region of Iraq is facing what could be insurmountable debt problems. A massive injection of cash is needed in the short term to keep the company going, and negotiations with bond holders could well end with a debt-for-equity swap that wipes out existing shareholders.
Covering the middle ground, producers like Premier Oil and Tullow Oil should be strengthened by every dollar added to the oil price. Both are carrying hefty debt piles, but appear to have sufficient headroom to get them through — and Premier had enough cash to snap up E.ON’s North Sea assets recently, adding to its cash-generative capacity. For its part, Tullow is expected to be in profit this year and next, another big boost. Premier Oil shares have almost quadrupled to 74p since this year’s low, with Tullow doubling to 238p.
Looking at the wider market, its seems ironic that the FTSE 100 has been rising along with the oil price, as most companies are net consumers of energy and should do better with lower prices. But cheap oil does seem to damage sentiment.
China looking good?
And could better-than-expected demand from China signal a bottoming out in its slowdown? China’s state-directed financial sector is hard to fathom, so there’s plenty of risk there. But if things are improving it will hopefully feed through to commodities like iron and copper, and miners like Rio Tinto and Antofagasta should benefit.
And sooner or later, even China-focused banks like HSBC Holdings and Standard Chartered could start to look attractive again… though I think they have some way to go yet.
