As headlines of impending economic doom rain down on us, the temptation for this report to focus on the last 5 days, rather than the month of July is strong. The immediate economic outlook does indeed look grim, with both the EU and the USA confirming long-term stays in casualty wards. And to quote our May report, it now looks likely we will get what we wished for and oil prices will fall. They have certainly fallen heavily in the last 24 hours; crude down from $112 per barrel to $106, as oil markets react to a world where the 2 biggest collective oil consumers look likely to go AWOL.
However, the perspective of September should offer a cooler assessment of the current storm, so back to July and what was rather an uneventful month. Certainly, the IEA’s stock intervention (see last month’s report) had little effect other than what we saw at the end of June and the market actually rose. It started at 125.87 pence for a litre of petrol on 1st July and had reached 128.57 pence by the end of the month – proving once again that for better or worse, markets and not authorities control prices.
Probably the biggest news to digest in July was the announcement by ConocoPhillips (one of the 5 major oil multi-nationals – branded Jet in the UK) that they were pursuing a plan to separate their business into two stand-alone operations: upstream exploration (ie, selling crude oil) and downstream refining & marketing (ie, selling the fuel we can actually use). This has long been an inevitable consequence of high crude prices and endlessly squeezed refinery margins. Yet like all watershed moments, however much we predict something, the impact when it arrives is still profound. The bedrock of the oil industry for the last 50 years has been the wisdom that oil majors have both upstream and downstream operations and ConocoPhillips have now consigned that wisdom to the dustbin. The next question is who will follow suit? BP are still searching for easy cash to help plug the hole of Deepwater Horizon and a downstream asset sale would do nicely. Furthermore, Chevron and Total have both given some signals that such a decision is under consideration.
Where did it all go wrong for the downstream part of the industry and how can it be such an unattractive market sector? Well the truth is that there isn’t much wrong with the downstream industry – it’s just everything is right with the upstream sector.
Let’s take a standard upstream operation, which despite the travails of time has changed little in its fundamental cost-base since the 1990’s. Back then, Crude Oil extraction cost $15 – $30 per barrel and even with the onward march of inflation, this figure remains largely accurate 20 years later. So looking at the table below, we can see a basic breakdown of profits for a large upstream operator, based on a “standard” production figure of 500,000 barrels (bbl) per day.
Table 1: Crude Oil Producer (500k bbl per day): Operating Profit Synopsis
Exploration Costs ($ / bbl) $30 $30 $30 $30 $30
Crude Sale Price ($ / bbl) $30 $50 $75 $100 $150
Daily Revenue ($m) $15m $25m $37.5m $50m $75m
Daily Operating Profit ($m) $0m $10m $22.5m $35m $60n
At $30 per barrel, Big Oil Ltd may be feeling a little uncomfortable, particularly if they have expensive or inefficient extraction operations. But at $50 per barrel, things are beginning to look up, with daily profits of some $10m. On to $75 a barrel and the daily profits are rolling in and by $100 (give or take where we are today), Big Oil Ltd is bringing in $35m of operating profit every day. That’s 7 days a week, 52 weeks of the year. In monetary terms, that’s circa $1bn per month and $12bn per annum.
The relevance of this of course is not how impressive upstream oil companies are (they really are), but just how impressive a downstream organisation needs to be to even get a mention in the Board Report. In fact, how on earth can a downstream operation or heaven forbid a petrol station network, compete with these figures? The fact is that they can’t and they don’t, so in the brutal economics of the modern oil major, the decision of ConocoPhillips looks entirely logical.
So as this report is written, markets are plunging worldwide and a second recessionary phase seems ever more likely (the long-awaited double-dip?), but the oil producers of the world can be heard quietly saying “recession, what recession?”