The State of the Oil Industry, Part 1

What the energy market looks like after a turbulent quarter

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Aug 14, 2020
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As most investors know, the last six months have not been kind to the energy industry. Oil producers have been hit by a double whammy of oversupply (due to fractures in the OPEC-Russia alliance) and plummeting demand (due to global lockdowns). As a result, oil prices fell to multidecade lows earlier this year, with prices even going negative in some futures markets.

We won't go into the specifics of how this is even theoretically possible, but you don't need to be a professional oil trader to understand that a negative price for a commodity means that producers of that commodity are facing some serious challenges. In this series, we will be doing a deep dive into the state of the oil industry.

A mostly grim quarter

Now that the dust has settled on the most recent round of earnings calls, there are a few interesting points to note about the problems and prospects for the oil majors. One common theme that emerged in the earnings calls of many oil companies - especially the European giants - have been massive impairment charges (that is, writedowns in the stated value of assets on a company's balance sheet).

As an example, British Petroleum (

BP, Financial) posted a second-quarter loss of $16.8 billion, which included $9.2 billion in impairment charges. Royal Dutch Shell (RDS.A, Financial)(RDS.B, Financial) posted an impairment charge of almost $17 billion for the quarter. These charges came about mostly due to a downward revision in its estimates for future oil prices, as well as a review of existing exploration projects.

However, it wasn't all doom and gloom for oil companies as their in-house trading desks posted exceptionally strong results for the quarter. The elevated volatility that has been a hallmark of energy markets over the last quarter was a boon to trading desks, which offset losses in the production department.

Incidentally, it's quite a common thing for trading activities to compensate for losses in other parts of a company - it happens all the time at investment banks. During low-volatility bull markets, traders have less to do (relatively speaking), while corporate advisory and mergers and acquisitions teams do very well. During turbulent bear markets, when there are fewer deals happening, trading desks act as a hedge against falling stock prices and general uncertainty. Trading desks at oil majors in particular have a significant edge because they can liaise with the production and storage side of the business, and therefore have a superior insight into the market, so it is unsurprising that they did so well.

Still, it's hard to say that this quarter was anything other than a disaster for oil producers. In the next part of this series, we will look at what the oil slump has meant for these companies' dividend policies.

Disclosure: The author owns no stocks mentioned.

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