By 24/7 Staff / www.supplychain247.com / August 10th, 2015
As drivers, shippers and airlines continue to enjoy lower fuel prices, the oil industry is responding to much lower profits with sharp cuts in spending and employment that are hurting economic growth.
Low oil and gas prices are good for the overall economy because they reduce costs for consumers and businesses.
U.S. economic growth was higher in the second quarter, and economists say that was partly fueled by consumers spending some of their savings on gasoline at stores and restaurants.
But with oil prices down around 50 percent from last year, major oil companies are cutting back, offsetting some of this good news.
For instance, Exxon Mobil said it cut spending by $1.54 billion in the second quarter, while Chevron announced it is laying off 1,500 workers.
Until about six months ago, booming U.S. oil and gas production was helping the country’s economy grow during a time of economic sluggishness.
David Kelly, chief global strategist at J.P. Morgan Asset Management, said this week that a $29 billion decline in oil exploration and mining activity in the U.S. cut economic growth by 0.7 percent in the second quarter, a sizable chunk for an economy that grew 2.3 percent.
Investors also feel the pain. Lower oil profits have an outsized effect on stock markets because the companies are so enormous. Analysts at RBC Capital Markets wrote that when oil prices drop by 10 percent, earnings for the overall S&P 500 fall by 1 percent.
Industry layoffs seem to be accelerating. Royal Dutch Shell, while announcing that profits fell 25 percent in the second quarter, said it would cut its global workforce by 6,500. Chevron’s quarterly profit fell 90 percent, and CEO John Watson said the company is reducing its workforce “to reflect lower activity levels going forward.”
BP CFO Brian Gilvary told investors that the company has been cutting workers, “and I think you’ll see more of that before we get to the end of the year.” BP’s oil and gas profit dropped 64 percent from April through June.
Exxon Mobil’s profit fell by half, to its lowest level since the recession of 2009, the company said Friday. Its operations in the U.S. - the center of the global oil and gas boom - posted its second straight quarterly loss.
“The surprise really was here in the U.S.,” said Brian Youngberg, an analyst at Edward Jones.
Shares of Exxon and Chevron, both components of the 20-member Dow Jones Industrial Average, fell 4 percent last Friday after they announced results.
The companies are in some ways victims of their own success. A surge in oil and gas production brought on by technological advances and high prices in recent years has flooded the market, sending global prices sharply lower.
But geopolitical forces have also increased the pressure on prices. Iranian oil is poised to return to the world market after years of sanctions, the Greek debt crisis is reducing economic growth in Europe and a shake-up in Chinese financial markets is reducing demand growth in the world’s second- largest oil consumer.
After nearly four years near $100 a barrel, the price of oil began slumping a year ago, falling to $43 by March. It surged briefly all the way to $61 in June but then fell again. Oil traded just above $47 a barrel on Friday.
That has translated to sharply lower fuel prices. The U.S. average retail price of gasoline through the first half of the year was 30 percent lower than during the same period last year. Last Friday, the national average was $2.67 a gallon, 85 cents lower than last year at this time, according to AAA.
Retail prices for diesel and heating oil have averaged 27 percent lower than last year, and airlines have posted some of their highest profits in years thanks to lower jet fuel prices.
These low prices, along with the pain for the oil industry and pleasure for consumers, are likely to continue for a while, analysts say. There is plenty of oil in storage tanks, and the global oil industry has the capacity to produce more if demand picks up.
In a report last Friday, IHS Energy analysts predicted further declines in oil prices. IHS says oil will have to fall into the low $40 range and stay there for “several months” before U.S. production growth slows and the supply glut eases.
“It’s not good news for producers,” said IHS Chief Economist Nariman Behravesh. “It’s very good news for U.S. households, consumers, and transportation companies.”
Impact of lower oil prices on the transportation sector: Is it all good news?
The drop in oil prices is having a dramatic impact on the transportation sector.
With fuel costs down, transport companies are able to save money. Consumers are saving money, too, which adds to the positive effect on global trade and some modes of transportation.
But such a big change in the environment also has a disruptive side because it opens up a new range of possibilities. Companies may have to reconsider routes and rethink their competitive strategy.
We recently took a look at some of these impacts across the industry.
A major component of operating costs, fuel is a big boost to the bottom line. Some airlines are locked into hedging contracts that cut into profits. However, airlines can now re-write their hedging contracts to lock-in current price levels.
With higher profits, airlines could introduce new routes and expand capacity on existing routes. This would allow them to get more use out of their planes or even acquire additional planes. It’s also possible that if demand falls and capacity expands, an increase in competition will result in lower fare prices.
Many airlines have placed large orders for newer, more fuel-efficient planes, but now they might decide to delay orders. On the other hand, with more cash available, this might be a good time to modernize fleets. Or, airlines could spend their money to make flying more comfortable, which could help win new customers.
Lower oil prices are good for the freight rail industry in the short term. This pricing allows operators to make more money, and it makes customers happy because they are paying lower fuel surcharges. But as oil prices fall, rail loses some of its cost advantage over trucking. Some customers may then turn to trucking, which is generally faster. So rail operators need to work on improving reliability and speed. Operators may also consider route changes that could make them more competitive.
Operators of passenger rail face a different threat. With cheaper oil prices, more people are likely to drive their own cars rather than take public transit. However, other travelers may stick with rail, especially for commuting, because of traffic and environmental concerns.
Lower fuel pricing really benefit truckers. It narrows the price gap with rail and makes it more competitive. In fact, it’s helping trucking companies recapture customers they lost. Longer term, lower fuel costs mean truckers can adjust their networks and routes to better serve their customers. And it allows trucking companies to keep older, less fuel efficient vehicles on the road for longer.
Ocean shipping companies benefit from lower operating costs and higher margins in the short term. But it also means that shippers need to think about the kinds of ships in their fleet. When oil spiked in 2008, many companies turned to newer, more efficient ships, reduced travel speeds, and consolidated to larger vessels. Now, companies can redeploy smaller, faster, and less fuel efficient vessels on certain routes. They could also postpone the purchase of new ships and hold on to profits.
Looking broadly across all modes of transport, the fall in oil prices means higher margins for transportation operators and some pass-through savings to customers. Longer term, it opens up a variety of strategic opportunities for transportation companies. But it’s hard to predict how long these oil prices will last. So prudent companies are hedging their bets and proceeding with caution.
Plunging Oil Prices a Boon for Logistics Companies
A global glut of crude is boosting profits at companies that transport and store oil, though that isn’t helping share prices
As reported by Robbie Whelan of the Wall Street Journal, the logistics of the oil market is proving to be a lucrative business, even as the price of crude plunges toward multi-year lows.
Companies that transport and store oil and refined products, as well as manage shipping terminals reported soaring profits this week. The glut of crude driving down prices is also creating more work for petroleum logistics firms, also known as midstream companies. Higher volumes of oil being brought to market generally means more business for operators of pipelines, tanker trucks, storage tanks and marine terminals.
Tesoro Logistics LP reported second-quarter income of $72 million on Wednesday, more than twice its net income as the same quarter a year ago, citing big gains in oil production and an improving climate for its terminal and transportation businesses. Spectra Energy Partners and Arc Logistics Partners LP also posted earnings last week that exceeded analysts’ expectations.
But the stocks of these companies – many of which are set up as master limited partnerships, a corporate structure geared toward lower taxes and higher dividends – have suffered this year. Tesoro is down 15%, while Spectra is down 14% and Arc down 1.4% since January. The Alerian MLP Index, which tracks oil infrastructure companies, is down 24.1% since the beginning of the year.
Midstream companies’ share prices are getting caught up in the wider investor exodus from the oil market and oil-related stocks, analysts say.
“This industry is heavily retail-owned, and when investors see crude oil sell off, they think,’Oh, it’s energy, I need to sell it,’” said John Edwards, a Credit Suisse analyst.
Investors are also pricing in the risk that low oil prices cause producers to cut back, which would eventually hurt midstream companies, said Barclays analyst Brian Zarahn. For instance, fees from storing oil are on the rise as unwanted crude fills tanks around the world. But investors worry that won’t last.
“There’s concern that lower oil prices will eventually mean lower production, and lower utilization of the assets and fewer growth opportunities,” Mr. Zarahn said. “It’s a concern for the space as a whole because we’ve been through a very large buildout.”
“Our business is down substantially and we have had to institute layoffs at terminals,” he said.
He said he expects shipping to pick up if oil prices gets back to $60 a barrel, from around $44 a barrel today.
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