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Volatility in the oil market looks set to continue
This year has proved to be one of the most volatile times for the oil market in living memory.
In January the oil price hit $70 per barrel as tensions simmered between the US and Iran. Having then slumped on the hit to demand delivered by global lockdown conditions, US oil prices in late April briefly turned negative, while the global benchmark Brent traded at multi-year lows.
In just a few short weeks the tides have turned with Brent doubling in price and now back above $40 per barrel. However, the revelation that BP (BP.) will cut 15% of its global workforce shows the improved price picture is not driving complacency in the oil industry.
Unlike its peer Royal Dutch Shell (RDSB), BP has not yet cut its dividend. Yet it is hard to imagine it sustaining dividends given the scale of the planned redundancies.
In this context, the company’s second quarter results on 4 August are likely to be closely watched for any movement on dividends.
There are good reasons for caution on oil’s revival, whose price rebound can be attributed to three main factors.
Oil producers’ cartel OPEC (and allies like Russia) has extended deep production cuts which has supported the oil price. There has also been a wider return to so-called risk assets (stocks, commodities) evident in the S&P 500 stock index surging close to pre-Covid levels.
Thirdly, the dollar has weakened. A weaker dollar makes it cheaper for foreign buyers to purchase dollar-denominated commodities such as oil.
‘MEANINGFUL’ DOWNSIDE RISKS
Investment bank UBS says prices have reached levels ‘where meaningful downside risks are starting to build’.
These risks include a potential increase in US shale production in response to firmer pricing, a similar move on the part of OPEC members, and the waning of a recent surge in Chinese imports. There is also reduced incentive to shut in production and a fragile recovery in demand as the world staggers out of lockdown.
What is clear from the recent actions of Shell and BP is that they will not miss the opportunity created by market dislocation to reposition themselves.
Shell had a perfect excuse to cut its dividend, ending a track record which went back to the Second World War, and rebase it at a more sustainable level.
BP’s job cuts likely relate to the short-term impact of oil’s collapse. However, from the outset of his tenure in January, chief executive Bernard Looney signalled an intent to reshape the business, looking to remain relevant amid a transition away from fossil fuels.
Cutting dividends could ultimately prove an important step in that direction as the company rethinks how it best deploys its cash.