I’m writing this article on the morning of 21 April 2020 (Tuesday) in Singapore. On the night of 20 April 2020, the price of oil fell to negative territory. I’m referring specifically to contracts for deliveries of West Texas Intermediate (WTI) crude oil in early May.
Here are some quick thoughts I have on this development…
1. Scott Sagan, a professor of political science, once wrote that “things that have never happened before, happen all the time in history.” Last night was the first time ever that oil prices became negative. Historic and fascinating? Yes. Surprising? It shouldn’t be. Crazy things happen all the time in the world of finance.
2. I hope investors are not lured to invest in oil & gas stocks simply because the price of oil is now so low. There are two important things to note:
- Predicting the future of oil prices is practically impossible. In 2007, Peter Davies gave a presentation titled What’s the Value of an Energy Economist? He said in the presentation that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum (LSE: BP), one of the largest oil & gas companies in the world.
- Oil & gas stocks need not follow the movement of oil prices. In mid-2014, oil prices started falling from around US$100 per barrel. WTI reached a low of US$26.61 in February 2016 before doubling to US$53.53 just 10 months later (on 21 December 2016). I tracked the share prices of a group of 50 oil & gas stocks in Singapore’s stock market and found that over the same period, 34 of them saw their share prices fall. The average decline for all the 50 companies was 11.9%.
3. Investing in an oil & gas stock also means the need to study its financials and – especially in today’s climate – its balance sheet. Even before the historic slump in oil prices on Monday night, there have already been oil & gas companies in the US effectively going bankrupt (see here and here). And speaking of financial trouble…
4. I fear for Singapore’s oil & gas giant Sembcorp Marine (SGX: S51). As of 31 December 2019, Sembcorp Marine, which builds oil rigs and other types of vessels, had S$389 million in cash but S$1.4 billion in short-term debt and S$3.0 billion in long-term debt. The company had S$2.9 billion in short-term liabilities but just S$2.5 billion in short-term assets. Of the short-term assets, only S$389 million is in cash; the bulk of it are in “contract assets” worth S$1.5 billion. Unfortunately, “contract assets” consist of recognised revenue for ongoing projects and don’t represent real cash until the projects are delivered. In crisis situations – and we are in a crisis situation – all liabilities become real and most assets except cash have to be heavily discounted.
5. Given the rapid deterioration in global economic conditions since end-2019, it’s likely that Sembcorp Marine’s financial health has weakened significantly from an already poor condition from what I just described in Point Four. The good thing is that Sembcorp Marine’s majority shareholder is Sembcorp Industries (SGX: U96), which is controlled by Temasek Holdings, one of the Singapore government’s investment arms. So it’s likely that financial support for Sembcorp Marine will be strong, if push comes to shove. That said, financial support for Sembcorp Marine does not necessarily mean that its shareholders will end up fine on the other side of this crisis.
6. I’ve stopped having an interest in investing in oil & gas companies for many years because I know my limitations. Investing in oil & gas companies, in my opinion, requires skills that I don’t – and will never – have. I just hope that investors who are tempted to invest in oil & gas stocks because of the historical fall in oil prices on Monday night are fully aware of the risks involved and go in with their eyes wide open.
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