Oil: A house of cards

Greg Bennett

At the start of 2015, the median oil price being used by analysts was $80 and $85 for 2015 and 2016. Currently it is $55 and $58 – a 30% cut in the most important modelling assumption – unsurprisingly resulting in negative earnings revisions. Notwithstanding these revisions, many oil stocks remain resilient.

This is because most analysts and investors believe oil will be materially higher in the near future and are looking through current weak earnings. However, the world has been over-producing oil every quarter from the start of 2014. Since oil was last over $100, global production is up 3.6m bbl/day. The largest contributors to supply growth has been Iraq and Saudi taly has unveiled an initiative to minimise non-performing loans (NPLs) in the country's banking system, which will involve securitisations supported by a government guarantee. The programme is known as GACS - Garanzia sulla Cartolarizzazione delle Sofferenze.

Despite some unrealistic expectations in the market, this initiative is not a ‘bad bank’. Each participating bank can create one or more SPVs, which will acquire NPLs and be financed through the issuance of asset-backed securities.

In contrast to the bad banks in Ireland and Spain, the Italian baddebt problem is concentrated in loans to SMEs, not to households or construction. The high NPLs in Italy are a function of the GDP Arabia, Russia, the Gulf of Mexico and Asia. Even if, as the IEA expects, US shale production falls by 600k bbl/day next year, the world currently over-produces oil by 1.6m bbl/day. Also, global inventories are at levels not seen for more than two decades.

The clear risk is oil continues to stay at current levels, or lower, over the near term. Producers will not cut due to economics, while Saudi Arabia is unlikely to cut until it achieves its aims. This would mean significant downward revisions to earnings expectations and valuations for the sector. Equally, it will mean recent M&A and debt issuance, based on budgeted higher oil assumptions, may not be as economical as first thought. A veritable house of cards.