By late 2014 the world oil supply was trending to rise much higher than global demand; starting in September 2014 prices of oil began a sustained decline that would take it from over $100 a barrel to most lately hovering between $45-50 dollars per barrel.
By late 2014 the world oil supply was trending to rise much higher than global demand; starting in September 2014 prices of oil began a sustained decline that would take it from over $100 a barrel to most lately hovering between $45-50 dollars per barrel. Demand has been weakened from financial slowdowns in Europe and Asia as well as continued development of renewable energy. The largest driver of this increased global supply has been the advent of new technologies in North America over the last decade that have allowed for extraction of gas from shale through hydraulic fracturing as well as the price of oil being high enough to make the extraction of oil from the oil sands in Alberta Canada profitable.
Over the last few months the oil rig count in North America has experienced one of the most severe drops seen in the last 7 bear oil markets, having dropped from over 1,900 rigs to 1,750 in the span of two months. Because many of these rigs have already incurred much of the upfront costs to establish them even at $45 oil they can still produce profitably and supply while it is expected to come down due to low global oil prices will do so over a gradual timeframe thus continuing to put downward pressure on pricing for what is expected to be at least the next 6-8 months.
This decline in oil prices and investment in new drilling has already begun to have a negative impact on Oil Country Tubular Goods (“OCTG”) and other drilling materials. From October to January market prices for OCTG have declined between 4-5% which was moderated because of open orders already having been in place but with the recent declines in rig count and announced reductions in capital expenditures for new oil exploration in 2015 it is expected that OCTG prices may decline another 15-25% by the end of February of this year and have continued downward pressure the balance of the year. One of the challenges in the sector is that OCTG is typically a slower turning inventory so as prices decline many companies may already have approximately 6 months’ supply of inventory on-hand on average with these market price declines reducing its value. On top of the declining demand putting downward pressure on market prices the raw inputs for making steel including iron ore, scrap and energy have also all come down further depressing market values as less expensive inventory can now be produced. One moderating factor to declining OCTG prices will be the already announced reduced output of tubular good producers U.S. Steel and Tenaris SA. Given this current volatile environment Hilco strongly recommends that lenders increase the frequency of collateral valuations tied to the Oil & Gas space and where possible reduce availability.
In a related topic there is growing global concern coming from the steep decline in copper, which is used in many products and is often utilized as a gauge on how China is performing. The price of copper hit its lowest price since 2009 at $2.46 a pound recently. Copper is down nearly 7% this last week alone. Investors are exiting commodities, like copper, as oil prices continue to fall. Copper is also priced in dollars, which makes it less attractive to foreign buyers as the dollar has strengthened. For companies with copper as its collateral faster turning inventories should self-adjust to these declines but those with slower turning inventories should be closely monitored.
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Senior Vice President
Hilco Valuation Services