My experience dabbling in the stock market tells me one thing, the market will always have a way to surprise you. Always expect the unexpected. Two years ago, it would be insane for anyone to think that the oil price would drop below USD40 per barrel. At that time, there was so much talking about the world running out of oil and the push for alternate energy source.
Today, it is clear to all of us. There are plenty of oil to last us for the next 100 years and the high oil price has always been due to the greed of a group of countries controlling the supply. Such artificial high oil price has not only enable these countries (and oil companies) to reap abnormal profits but also push poor non-oil producing countries into permanent poverty.
There is no limit to human's greed. I am glad, finally, there are competitors that have brought some sense back to the industry. Introducing the shale producers and Russia.
OPEC, led by Saudi, responded by flooding the market with oil, sending prices to new lows and hoping this will drive out competitors. Will this work? Yes, it may work but oil price will remain subdued for a long long time simply because these competitors can break even at the price between USD40 to USD60 and the best of all, shale can be restarted with a short period of time if the price is good. So this OPEC strategy does not really drive out the competitor, it only cause them to suspend production temporarily until the price is profitable.
But the problem doesn't stop there. The oil industry is supported by contractors that have made investments on assets based on the assumption that the good times will last forever. While some may claim that their investment model has taken into account some occasional industry dips, I bet none of them (or anyone of us) expected the price of today which will eventually lead to the total collapse of the supporting industry.
Why I think it will collapse? Well, assets were purchased at a high price, financed mostly by debt and is now either idling or operated at a revenue far below the break even price. Some of these companies may have some reserves to fund the negative cash flow but if this low oil price condition is going to be permanent, you can guess the outcome. By the way, it is already too late by now for these companies to raise fund via equity as they can hardly raise any thing substantial under such industry sentiment and the need to meet the private placement capping. It's like waiting to die.
The sad part doesn't end here. When oil price was dropping significantly way back in December 2014, the management team of these companies was still clinching on the hope that the industry would recover. Even at that point, anyone can already deduce the chance of recovery is only possible if the following can take place:
- US and Russia cooperate with OPEC on production quota
- A war breaks out in the Middle East, disrupting the supply
- Fracking is banned in US due to environmental concern
The above scenario is not likely to happen while hoping a war to break out and save the industry is just not right. Nevertheless, there was just no solid action plan by the management team even when the impending consequence can be guessed and their corporate strategy was rather reactive.
How this "likely consequence" will affect our economy? One thing for sure, there will be lay-off. Employees hired under contract will be laid off with a one-month notice if the asset operated by them is idling. Hopefully, these people have saved some money during the good times as there won't be any compensation, as per the contract. There will also be pay cut for management staff.
Such lay-off and pay cut may sometime trigger contraction in consumer spending and perhaps, investment in property. In fact, it was reported not long ago that some high end properties were rented out at lower rates due to reducing demand by expatriates, mainly working in the oil and gas industry. Perhaps, the property sector may witness some slowdown and potentially, price reduction soon. Many people these days would not believe that property price will drop but then, everyone in the oil and gas industry were having the same notion as well previously. Let wait and see how this will play out.
Then there are companies supporting the contractors, known as third tier oil & gas companies or subcontractor. These companies generally are manpower suppliers, caterers, helicopter operators, hotels located near to the supply bases, ship yards and even airlines. When there is low oil and gas activity, all these supporting industries will be impacted.
I still remember 2 years ago, I need to book a hotel room in Labuan one month in advance and the most expensive hotel got filled up first and thereafter, lower grade hotels. All these was due to the demand from the oil & gas industry, always giving the best to their employees. But today, you can just check into any hotel in Labuan and rooms are always available. I am sure unannounced lay-offs are taking place in these companies as I write. If the employees laid off do not get another job, they will have difficulty in financing their mortgages and we can all guess the next chain of event.
By the way, those who follow the share analysts would haveread about the opportunity for some merger and acquisition to take place, noting that some oil and gas contractor companies were having cash reserves to do so. Such naive speculation by the analysts was highly questionable as these companies needed the cash to weather this crisis and stay afloat. It would be unthinkable for them to even commit on acquisitions if they can hardly make ends meet.