The Great Oil Depression is coming (maybe)

The Great Depression of the 1930’s was brought on by just a couple escalating situations. One was a loss in faith is the stock market which resulted in Black Tuesday. The other was massive failures in the core financial institutions, similar to what happened in 2008 and 2009 with Lehman Brothers, Bear Sterns, AIG, Fannie and Freddie, and so on. When banks fail or stall, credit freezes and then spending stops. If millions of americans can’t take out a loan to buy a home or start a business and current businesses can’t maintain or open lines of credit to keep day-to-day operations going, then everything quickly comes crashing down. Money is pulled out of checking and savings accounts, spending stops, main street businesses go under, unemployment skyrockets, crime increases….it just keeps going. Today’s oil industry is seemingly creeping down a very similar track and while folks in the renewable energy sector may be excited for Big Oil to be on the brink of a Great Oil Depression, they may want to be careful what they wish for. Here’s what’s going on….

Oil lives and dies by only two factors – oil and natural gas prices, and refining margins. There’s two smaller business’s under one larger one in oil. One is downstream businesses, which include refining crude into gasoline, oil trading, and gas stations. The other is their upstream units, which extract crude and natural gas.  Oil companies have relied on downstream businesses to shield the losses from their upstream units since energy prices crashed in 2014. But in June, it appears that oil’s margins’ hot streak is over and disaster may be on the horizon.

BP’s downstream earnings in Q2 2016 fell to $1.51 billion from $1.81 billion in the Q1 2016 and $1.87 billion a year ago. BP’s refining margins were also the weakest for the April-to-June period in 6 years. The company also predicts that Q3 could get much worse for the oil giant because their in-house are $10.70 a barrel. This time last year it was $20 a barrel…so their margins have been chopped in half! This massive decrease in margins and predictions aren’t isolated to BP as many other oil majors are seen their margins drastically reduced and are anticipating weaker margins in the near future.

So what was the main cause of this?

Simple…demand. Right now, there is too much refined products, specifically gasoline, in the market and not enough demand for these products. U.S. gasoline futures are $1.31 today. The drop in gasoline is dragging down crude as investors fear that refiners, facing low margins, will cut output. West Texas Intermediate (WTI) is trading at $39.38 a barrel today, down about 57% from it’s peak in July 2014 and down about 25% from early June.

The Great Depression of the 1930’s was brought on by just a couple escalating situations. One was a loss in faith is the stock market which resulted in Black Tuesday. The other was massive failures in the core financial institutions, similar to what happened in 2008 and 2009 with Lehman Brothers, Bear Sterns, AIG, Fannie and Freddie, and so on. When banks fail or stall, credit freezes and then spending stops. If millions of americans can’t take out a loan to buy a home or start a business and current businesses can’t maintain or open lines of credit to keep day-to-day operations going, then everything quickly comes crashing down. Money is pulled out of checking and savings accounts, spending stops, main street businesses go under, unemployment skyrockets, crime increases….it just keeps going. Today’s oil industry is seemingly creeping down a very similar track and while folks in the renewable energy sector may be excited for Big Oil to be on the brink of a Great Oil Depression, they may want to be careful what they wish for. Here’s what’s going on….

Oil lives and dies by only two factors – oil and natural gas prices, and refining margins. There’s two smaller business’s under one larger one in oil. One is downstream businesses, which include refining crude into gasoline, oil trading, and gas stations. The other is their upstream units, which extract crude and natural gas.  Oil companies have relied on downstream businesses to shield the losses from their upstream units since energy prices crashed in 2014. But in June, it appears that oil’s margins’ hot streak is over and disaster may be on the horizon.

BP’s downstream earnings in Q2 2016 fell to $1.51 billion from $1.81 billion in the Q1 2016 and $1.87 billion a year ago. BP’s refining margins were also the weakest for the April-to-June period in 6 years. The company also predicts that Q3 could get much worse for the oil giant because their in-house are $10.70 a barrel. This time last year it was $20 a barrel…so their margins have been chopped in half! This massive decrease in margins and predictions aren’t isolated to BP as many other oil majors are seen their margins drastically reduced and are anticipating weaker margins in the near future.

So what was the main cause of this?

Simple…demand. Right now, there is too much refined products, specifically gasoline, in the market and not enough demand for these products. U.S. gasoline futures are $1.31 today. The drop in gasoline is dragging down crude as investors fear that refiners, facing low margins, will cut output. West Texas Intermediate (WTI) is trading at $39.38 a barrel today, down about 57% from it’s peak in July 2014 and down about 25% from early June.

U.S. gasoline futures

U.S. gasoline futures

West Texas Intermediate (WTI) trading

West Texas Intermediate (WTI) trading

What’s being done to stay afloat?

It’s very clear that the oil major’s reliance on their “integrated” model of upstream and downstream businesses to cushion periods of low prices isn’t a model that they can depend upon long term. Downstream cash flow is drying up and it isn’t going to get better. So they will have to cut *discretionary capital/cash spending for the rest of this year and 2017. BP has stated that they had to adjust heir 2016 investments by about $17 billion and will only invest about $15 billion next year, far less than original plans.

*Discretionary cash flow is any money left over once all possible capital projects with positive net present values have been financed, and all mandatory payments have been paid.

Is their any good news from all this?

While refining, oil trading, and gas stations are a fraction of what they used to be, downstream is still able and keeping their upstream business alive at a level slightly above life support (for now). The current margins are also a lot higher than that bleak levels of the late1990s and early 2000s. when their margins were $5 to $7 a barrel. So it could be worse I suppose :/

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