Oil Price Volatility - Report Example

Report: Oil Price Volatility Name: Course: Tutor: Institution: City/state: Date: Report: Oil Price Volatility Introduction Crude oil is a critical product that has a strategic importance to all states and markets around the world. However, the oil market in recent years has been exposed to a period of volatility. It is important to note that crude oil availability and flexible prices have contributed to the economic growth of emerging markets such as China and others in Asia. After the recent unpredictable financial crisis of 2007/2008, the commodity and financial regulation of crude oil has evolved. In addition, this has resulted in distrust and uncertainty in the market, giving rise to high levels of price volatility. Crude oil has evolved significantly since the 1850s to refined products such as diesel, gasoline, and other petrochemicals. These components are used in the manufacturing a variety of chemical products such as paints, detergents, plastics, and medical products. Research is indicative of the relatively strong correlation between crude oil activity and economic activities around the world. Following more than 4 years of stability in oil prices at $105 for a single barrel, the prices of oil have witnessed significant decline since the month of June 2014. It is anticipated that the prices of crude oil will remain low for the subsequent periods to come. The decline in process is noted as an end to the commodity supercycle, which started in the early 2000s. In addition, previous episodes of significant decline have coincided with considerable fluctuations in economic activity and high incidences of inflation. The factors and consequences of policy on the decline in oil prices have brought about intense debates. In essence, the significant decline in oil prices since the month of June 2014 is not an unprecedented event. In the past three decades, there have been an estimated 5 episodes of oil price plunges of an estimated 30% in relation to shifts in the global economy and more so the oil markets. Additionally, research indicates that the recent decline in oil prices is attributable to a variety of factors namely I. Reduction in global demand for crude oil II. Steady upward trend in production of unconventional forms of crude oil III. Shifts in OPEC policies IV. Geopolitical risks V. Appreciation of the American dollar It is noted that the relative importance of each single factor is a challenge to identify with accuracy. However, the announcement of price support and improvements in oil supply sourced from unconventional sources by the OPEC is understood to have played a critical role in the decline of prices of crude from mid 2014. Empirical estimates from research provide that the supply factors, which have exceeded global demand, have been critical towards the recent decline in oil prices. Despite the supply capacity for a number of the high cost producers such as shale producers in the United States, there will be a need to adjust to appropriately low prices (Singh, Drosjack, & Linden, 2014). A majority of these factors are indicative of the persistence of low prices over the medium-term with high levels of volatility anticipated in the international oil markets. In addition, the decline in oil prices is anticipated to give rise to real income changes from the oil exporters to the oil importers resulting in a net positive effect in international activity in the medium term. A supply induced reduction of an estimated 45% in the global oil prices would be related to an increase of 0.7-0.8% in global Gross Domestic Product (GDP) (Vanderburg, 2014). In addition, it is anticipated that this would also induce decline in global inflation by 1%in the short-term period. Furthermore, activity in oil importing countries could accrue benefits from the relatively low oil prices given that a decline in price induces corporate and household incomes. Royal Dutch Shell PLC draws on scenarios in terms of anticipated events and occurrences in the oil and gas markets in the near future for strategic decision-making. The decision to select Royal Dutch Shell was because of its strategic role and positioning in the international oil and gas industry (Serletis, 2013, 39). This report evaluates the role of recent price decline in the global oil markets, the inducing factors, and subsequent effects on decision-making amongst oil and gas companies operating in the global market. Royal Dutch Shell PLC is one of the largest private oil and gas companies in the world in terms of market capitalization, production, and operating cash flows. Its activities are divided into: I. Exploration II. Development and extraction III. Manufacturing and energy production IV. Transport and trading Critical Analysis New Projects In the year 2014, the entity embarked on production in the Gumusut-Kakap deepwater project located in Malaysia, Cardamom, and Mars B in the Gulf of Mexico the United States. Other projects include the Bong North West project located in the coast of Nigeria. In addition, it is noted that the entity has undertook investments in the expansion of the integrated gas business that was marked by acquisition of a part of the Repsol South Africa liquefied natural gas segment and supply positions in Trinidad and Tobago and Peru. Given the volatility the oil and gas industry, the industry was able to undertake investments in biofuel production and retailing in Brazil through its Raízen venture. The future of gas and oil production will rely on the ability to access provided viable reserves by undertaking exploration and negotiations with states and owners in reserves and acquisitions. Furthermore, this will also be undertaken through development and application of new and emerging technologies as well as recovery processes for existing mines and fields. The failure to replace existing reserves may give rise to lower production levels in the future leading to decline in earnings and cash flow (Vanderburg, 2014, 23). Innovation and adoption of new technology are critical to shell in meeting the global demand for oil. In addition, this is imperative in a volatile market as it enables achievement of the desired cost efficiencies for the organization. The emergence of new technologies is also marked by concerns over the environment and the wellbeing of staff. This means that adoption of new technology should be with respect to cost, environmental and safety concerns to eliminate incidences of revocation of licenses and liability over safety and environmental concerns. In joint ventures or engagements with associates, the entity lacks control and influence over the conduct, costs of operation and performance of a given project. The lack of control and influence over new projects exposes the entity to numerous risks associated with such operations such as litigation, reputation, and governmental sanctions. For instance, involvement in developing countries, the lack of infrastructure and access to financial services may render projects unviable. Cancellation of Projects The cancellation and progression of projects is determined by operational issues, weather, natural disasters, conflicts, political instability, economic conditions, and actions/policies by oil producing states. It is noted that the volatility of oil and gas prices has a significant effect on the business activities in terms of earnings and cash flows. It is noted that the presence of low prices would result in low revenue in the Upstream production units, which may render some of the long-term projects unprofitable. In addition, low oil and gas prices may inevitably render viable oil and gas reserves unprofitable. The low oil and gas prices could influence the ability of the entity to sustain its long-term investment program. On the other hand, high prices could result in decline in demand for the entity’s products thus lowering profitability especially in the Downstream business segments. The entity notes that given the volatility of the oil and gas industry, it resorted to reduction of its liquids rich and tight gas shale portfolio to reduce possibilities of significant losses. Oil and Gas Production availed for Sale 2014 2013 2012 Shell Subsidiaries 895 850 825 Shell –Joint Ventures and Associates 229 318 369 Total 1,124 1,168 1,194 Proved Developed and Undeveloped Oil and Gas Reserves 2014 2013 2012 Shell Subsidiaries 10,181 10,835 9,873 Shell-joint ventures and associates 2,900 3,109 3,701 Total 13,081 13944 13,574 Attributable to Non-controlling interests 11 12 18 Attributable to Royal Dutch Shell Plc 13,070 13,932 13,556 Divestment The entity undertook a variety of divesting activities in 2014 as a means of reducing risk in its portfolio. The net capital investment held by the organization reduced from $39billion in the year 2013 to $21billion in 2014. In addition, the capital investment was $31billion in 2014, whereby $8billion was the exploration expenditure inclusive of acquisitions of properties with unproved resources. The capital investment stood at $40billion in 2013. The divestment proceeds were an estimated $11billion in the year 2014 as compared to $1billion in the year 2013. The net capital investment for the year 2014 was low when compared to the year 2013 because of the high divestment proceeds and reduced expenditures on acquisitions. A large portion of the divestment proceeds for the year 2014 are related to the portion of shares held in Wheatstone and Woodside in Australia, Parque das Conchas (BC-10) in Brazil, Pinedale and Haynesville in the united states. The entity continued with its divestment strategy in its various Upstream assets in the year 2014 namely: I. The sale of 78.27 million shares in Australia’s Woodside for an estimated $3.0 billion and reduction of the interest held to 14% from the initial 23%; the sale of 8% shares in the Wheatstone-lago joint venture project; reduction of the 6.4% interest in Wheatstone LNG development that is currently under development at a sale worth $1.5 billion. II. Brazil sale its non-operated 20% share interest in BM-ES-23 agreement in Espirito Santos offshore project for $0.2 billion. III. In Canada, the entity sold its 100% interest in Orion steam aided gravity drainage development for an estimated $0.3 billion. IV. In Nigeria, the entity sold its 30% interest in the OML 24 facilities for an estimated $0.6 billion. In its Upstream Americas activities mainly the liquids rich and right gas shale, the entity completed an evaluation of its existing strategies and portfolio. The major divestments in non-core positions have been completed and those in 2014 were as follows: I. Haynesville tight-gas shale development located in Louisiana, USA for an estimated $1.1Billion that is inclusive of net adjustments in the closing period II. Pinedale tight-gas shale development located in Wyoming, USA sold for an estimated $0.9 billion that is inclusive of net adjustments in the closing period III. 155,000 Acres sold in Marcellus and Utica shale locations in the state of Pennsylvania, USA the provided an option for subsequent holding of 100% in Tioga Area of Mutual Interest (Houser, & Mohan, 2014, 17) IV. Sale of 106,000 acres in Eagle Ford shale region located in Texas USA, for an estimated $0.5 billion inclusive of net adjustments in the closing period V. Mississippi Lime land located in Kansas, USA for an estimated $0.1 billion and additional assets worth $0.5 billion. The decisions for the divestments have been related to the need to increase cash flows for the entity and in the process reduce risks associated with the various offerings in its diverse portfolio. This is also related to the volatility of the oil and gas industry necessitating the need to free up existing assets to enhance cash flows for operational purposes. OIL AND GAS PRODUCTION AVAILABLE FOR SALE MILLION BOE ( Annually) 2014 2013 2012 Shell subsidiaries 895 850 825 Shell share of joint ventures and associates 229 318 369 Total 1,124 1,168 1,194 Strategic Acquisitions In the year 2014, the acquisition expenditure was relatively lower to that of 2013 that was inclusive of acquisitions in Libra and Parque das Conchas (BC-10) and expenditures associated with acquisitions of the LNG business segment in Respol South Africa. The first oil in Malaysia was produced at the Shell Gumusut-Kakap deepwater project with an interest of 29%. It is noted that peak production in this project is at an estimated 135,000 barrels per day. Works in the gas inject facilities are undergoing. In addition, other projects include the Siakap North-Petai project in Malaysia with a 21% interest holding. The project is anticipated to provide an estimated 30,000 barrels per day at peak production. In Nigeria, the shell owned Bonga North West deep-water project with a 55% stake is anticipated to provide 40,000 barrels per day at peak production. Oil in sub-sea locations is usually moved through sea pipelines to the floating Bonga production facility for subsequent process, storage, and offloading (FPSO) facilities that have been improved for handling additional capacities of oil produced. In the United States, the entity was able to undertake to primary start-ups in the deepwater locations of the gulf of Mexico with the initial oil produced from the Cardamom and Mars B projects with interests of 100% and 71.5% subsequently for Shell Plc. Production from these projects is anticipated to be at 50,000 and 80,000 barrels per day respectively. The acquisition of Repsol S.A.’s LNG segment was completed in the month of January 2014, which is inclusive of supply segments in Trinidad and Tobago and Peru purchased at $3.8 billion . it is anticipated that this will provide 7.2 million tones annually of the LNG volumes directly managed by undertaking long-term off-take engagements and including an estimated 4.2 million tonnes annually of the LNG plant production capacity. The entity undertook strategic investment decisions in the year 2014 namely Brunei investment in Maharaja Lela South project with interest of 35%. This project is anticipated to provide a peak production level of 35,000barrels per day. In Nigeria, the investment in the Bonga Main Phase 3 development with a 55% interest is anticipated to provide a peak production level of 40,000 barrels in the existing Bonga FPSO. REVENUE BY GEOGRAPHICAL AREA (EXCLUDING INTER-SEGMENT SALES) $ MILLION 2014 % change 2013 % 2012 % Europe 154,709 36.7 175,584 38.9% 184,223 39.4 Asia, Oceania Africa 149,869 35.6 157,673 34.9 156,310 33.5 USA 70,813 16.8 72,552 16.1 91,571 19.6 Other Americas 45,714 10.9 45,426 10.1 35,049 7.5 Total 421,105 421,105 451,235 100.0 467,153 100.0 Cost Efficiencies The entity faces numerous competition in all its business segments. Despite the efforts towards differentiation of its products, a majority of them are competing in volatile commodity type market segments. The failure to manage its expenditures with a high level of efficiency and accuracy would reduce its cost efficient and in the process increase unit costs. It is noted that the entity competes with state owned entities especially in seeking viable oil and gas resources. Currently, a majority of these state-run entities control significant quantities of gas and oil resources when compared to large public oil and gas industries. They have significant access to resources while they draw motivation from various social, economic, and political factors for decision-making. This may impede the entity’s competitive position and hinder access to desired resources and projects. It is noted that the recent financial crisis which has been related to the decline in oil prices and high levels of market volatility has prompted oil producing states to undertake polices geared to protecting their markets and industries. Shell’s joint ventures, subsidiaries, and associates are subjected to diverse financial and economic market conditions around the world. Political and economic volatility affects the global oil markets, within which the entity operates. With decline in revenues as a result of the price slump and overarching volatility, oil entities such as Shell usually divest to ensure improvements in cash flows. REVENUE AS PER BSUINES SEGMENT ( INCLUSIVE INTER SEGMENT SALES) 2014 2013 2012 Upstream Third parties 45240 47,357 43,431 Intersegment 47,059 45,512 51,119 Total 92,299 92,869 94,550 Downstream Third Parties 375,752 403,725 423,638 Intersegment 2,294 702 772 Total 378,046 404,427 424,410 Corporate Third Parties 113 153 84 Total 113 153 84 Recommendations 1. It is critical that the entity ensures it retains projects and activities which are deemed as essential towards success of its future given the high level of uncertainty in the future of the global oil and gas industry. A majority of the decisions undertaken by the management are critical towards survival of the operations of the entity in both long-term and short-term future of the organization. 2. Subsequent decisions should rely market conditions and prediction sin terms of future trends in technology in the oil and gas industry. It is anticipated that the prices of crude oil will remain low for the subsequent periods to come. The decline in process is noted as an end to the commodity super-cycle, which started in the early 2000s. In addition, previous episodes of significant decline have coincided with considerable fluctuations in economic activity and high incidences of inflation. The factors and consequences of policy on the decline in oil prices have brought about intense debates. In essence, the significant decline in oil prices since the month of June 2014 is not an unprecedented event. In the past three decades, there have been an estimated 5 episodes of oil price plunges of an estimated 30% in relation to shifts in the global economy and more so the oil markets. Conclusion Royal Dutch Shell PLC draws on scenarios in terms of anticipated events and occurrences in the oil and gas markets in the near future for strategic decision-making. The decision to select Royal Dutch Shell was because of its strategic role and positioning in the international oil and gas industry. This report evaluates the role of recent price decline in the global oil markets, the inducing factors, and subsequent effects on decision-making amongst oil and gas companies operating in the global market. As a result of uncertainities in the market and emergence of new alternative fuels, there is a need to reduce the number of new projects to save on cash flows and ensure minimal risks for loss of shareholder funds. The recent financial crisis in years 2007/2008, the commodity and financial regulation of crude oil changed rapidly which slowdown in economic activity and the demand for oil and gas around the world. In addition, this has resulted in distrust and uncertainty in the market, giving rise to high levels of price volatility. Its subsequent activities will be informed by the use of case scenarios to illustrate the responses that will be used by the organization towards meeting its obligation to the shareholders and other stakeholders. Bibliography Royal Dutch Shell Plc 2014, Strategic Report Year Ended December 31, 2014, Royal Dutch Shell Plc, London. Petrie, T. A. (2014). Following oil: Four decades of cycle-testing experiences and what they foretell about U.S. energy independence. Norman: University of Oklahoma Press Wator, M., & Frauendorfer, K. (2014). Long-Term Price Forecasts for European Crude Oil and Natural Gas Markets. St. Gallen. Klein, S., & Canadian Centre for Policy Alternatives. (2001). Costly energy: Why oil and gas prices are rising and what we can do about it : a collection of progressive analysis and policy alternatives. 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