The Impact of Oil Prices on the Energy Industry
Author: Randy Vogel
As oil prices continue to decline, the effects on the energy industry—as well as on other industries—continue to show themselves in a variety of ways.
The price of oil has dropped dramatically in recent months, from around $100 per barrel for West Texas Intermediate (WTI) during the first eight months of 2014 to approximately $50 a barrel in March 2015. This reduction in oil price and continued low natural gas prices mean the number of drilling rigs being used in the U.S. has declined by approximately 980 since the last quarter of 2014—down to 954 in mid-April 2015—and that number should continue to decline throughout 2015 as rigs are being stacked once their drilling commitments are completed.
Most major players in the U.S. oil field have announced significant reductions in their planned exploration expenditures for 2015—including more than 50 percent from SandRidge, 40 percent from Marathon, more than 30 percent from Anadarko and more than 10 percent from Exxon. Layoffs in the oil patch are underway, and once previously agreed-to drilling commitments are completed, more cuts should follow.
On the financial side, many companies face asset write-downs in 2015 as the price used to calculate reserve values drops from an average approximating $100 per barrel in 2014 to $50 in the first quarter of 2015. This will affect oil and gas properties, service equipment valuations and goodwill. However, not all the news is bad, as lower oil prices lead to lower gas prices—from $3.70 per gallon to less than $2.50—meaning more consumer dollars to spend, as well as increased profits through reduced fuel costs for many industries, including transportation and manufacturing. The price of hydrocarbons is causing a negative inflationary impact that could increase consumer spending, leading to more travel over the spring and summer due to lower fuel costs.
All economists do not share the same outlook, and areas that rely on the oil and gas industry may see greater effects than other parts of the country. According to the Texas Workforce Commission, Texas lost more than 25,000 jobs in March, representing the state’s first decline in 53 months. Although the cost reductions will help, the employment drop and a general reduction in wages will lead to less available cash for housing and discretionary spending in those markets.
The looming question: Will prices stay low? The current decline in oil and gas prices is caused not by decreased demand but increased supply. With the shale field revolution in the last several years, production has risen to all-time highs. Shale oil is much more expensive to extract than conventional wells, so the decrease in price may lead to tapering in exploration—as evidenced by the falling rig count. Although experts disagree on the timing, most anticipate oil will stabilize at some point in the $60 to $65 range, although with so many factors playing into the price, the industry has adopted a wait-and-see attitude.
Capital markets are expecting opportunities in the energy sector based on the reductions in price and service volume—as demonstrated by the large amounts of money raised—but there appears to be a disconnect between buyers and sellers on value, meaning capital remains on the sidelines waiting for better opportunities. However, the fund managers have to invest those dollars at some point, so the outlook for merger and acquisition activity in the energy sector remains strong.
To learn more about how changing oil prices could affect your organization’s financial situation, contact your BKD advisor.