Economic Impact

Oil Price Slump Heralds Tough Year

oil field_man in shadow_Fotolia
The oil wells aren't pumping out big profits these days.
  • Why it matters

    Why it matters

    The falling oil price poses global economic risks and German companies are bracing for a difficult 2016.

  • Facts

    Facts

    • The price per barrel of oil fell to less than $30 last week, its lowest level in 13 years.
    • German energy managers at the Handelsblatt Energy Industry 2016 conference predicted that the price would recover again because many oil development projects have been shelved — lessening future supply.
    • The DAX index of 30 leading shares has fallen 13 percent since the start of the year, partly due to concern about the economic impact of falling oil prices.
  • Audio

    Audio

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For drivers in Germany, the dramatic slump in the price of oil is a gift. Filling the tank hasn’t been this cheap for years.

Unsurprisingly, Mario Mehren, the chief executive of Wintershall, Germany’s biggest oil and gas producer, doesn’t share their delight.

“Oil is cheaper than mineral water at the moment,” he said at Handelsblatt’s Energy Industry 2016 conference in Berlin on Wednesday. “As the head of an oil and gas company, I’m finding it hard to express pleasure.”

The oil price slump has brought back memories of 2008, when the price tumbled from $140 to $34 per barrel in just four months. A global economic crisis ensued, and Germany suffered its worst recession since World War II.

“Oil is cheaper than mineral water at the moment.”

Mario Mehren, CEO of Wintershall

On Wednesday, the barrel cost less than $27, it lowest level in 13 years. The risks this poses for the global economy are huge, explaining why financial markets are on edge. The DAX index of 30 leading shares has fallen 13 percent since the start of the year. The Dow Jones has dropped 10 percent.

Larry Fink, head of Blackrock, the world’s biggest asset manager, has predicted a wave of insolvencies in the oil industry. Some experts estimate that up to a third of all U.S. producers will go bust by mid-2017.

Meanwhile, investors are cutting their forecasts for corporate earnings. Most expect that profits will decline in the coming 12 months. The last time investors were this pessimistic was three years ago, according to a survey by Bank of America Merrill Lynch among more than 200 asset managers.

The economic growth outlook is also darkening. The International Monetary Fund this week lowered its global growth forecasts by 0.2 points to 3.4 percent this year and 3.1 percent in 2017. Weaker growth will in turn hit demand for oil and put further downward pressure on the price — it’s a vicious circle.

German firms are beginning to brace for tougher times ahead. Automakers are selling fewer cars in former boom markets such as China, and sales also started to slow in the United States in December. Even reliable profit-generators such as auto components and tire company Continental are dampening expectations for 2016.

It’s particularly bad for luxury automaker BMW, which has been the biggest percentage loser in the DAX this year, suffering a drop to below €76 after starting 2016 at €100. BMW is a trailblazer for electric cars in Germany. With fuel costs down, demand for its battery-powered vehicles is waning.

Chemicals giant BASF has to factor in an earnings decline of several hundred million euros at its oil unit Wintershall this year as a result of the oil price drop.

The price slump has prompted companies to shelve investments in exploration and oil field development.

In addition, BASF is unlikely to profit much from cheaper oil, one of its key raw materials, because it will have to pass on the price drops to its customers. Many contracts stipulate that declines in raw materials prices must be passed on to customers.

Stefan Kreuzkamp, chief investment strategist at Deutsche Asset Management, the fund management arm of Deutsche Bank, said earnings in Europe and the United States “will likely have to be revised down by several percent.”

Mr. Mehren, the Wintershall chief executive, isn’t just worried about his own profit-and-loss account; he’s also concerned about the political stability in oil-producing nations if their revenues keep falling. “I fear that geopolitics isn’t influencing the oil market at the moment,” he said. “Instead,the oil price is influencing the geopolitical situation.”

Oil companies are astounded that the flareup of tensions in the Middle East hasn’t halted the slide in oil prices.

“Geopolitical developments of the sort we’re seeing now used to push up the oil price,” said Klaus Schäfer, the chief executive of Uniper, the fossil fuel spin-off of utility giant E.ON. “The current oil price is a burden for many countries.”

Russia’s budget is heavily dependent on revenues from oil and gas exports. “How long can Russia withstand that?” said Mr. Schäfer, noting that many countries in Africa, the Middle East and also Venezuela had budgeted for higher oil revenues. “Not for $100 per barrel, but definitely for more than $40.”

 

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The power of the oil producing countries has been broken, at least for the time being, according to Mr. Mehren. “OPEC has lost some of its significance,” he said. The cartel’s share of the world market has fallen because oil supplies from Russia, which is not a member, have risen, as has the volume of shale oil extraction.

“OPEC can influence the volumes but can no longer set the prices,” Mr. Mehren said.

Germany’s energy managers attribute the price declines mainly to the current weak level of demand caused in part by China’s economic slowdown.

However, the price slump has prompted companies to shelve investments in exploration and oil field development. As a result, German energy managers are convinced the oil prices won’t remain this low for long.

“We’re going to see a higher oil price in the foreseeable future,” Mr. Mehren said. “The oversupply of oil is very limited. In two, three, four years the lack of investment will have an impact on the price.”

Mr. Schäfer of Uniper noted that oil prices were rising just two years ago. “It can happen very quickly, not just downwards but upwards as well,” he said.

The head of German oil and gas company Dea, Thomas Rappuhn, also expects oil prices to rise because exploration and development projects amounting “several hundred billion euros” had been halted. “Production will fall,” he predicted.

But Mr. Rappuhn added that prices won’t return to the levels of 2014 when oil was trading at more than $100 per barrel. The development of shale oil deposits would ensure that the supply increases as soon as prices start rising again.

 

Jürgen Flauger covers the energy market for Handelsblatt, including electricity and gas providers, international market developments and energy policy. New York correspondent Thomas JahnRobert Landgraf, Handelsblatt’s chief correspondent for the financial markets, Anke Rezmer, who covers the investment fund industry for Handelsblatt out of Franfurt and Ulf Sommer, who covers companies and financial markets, all contributed reporting. To contact the author: flauger@handelsblatt.com

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