BLACK GOLD LOSES LUSTRE

Transcription

1 Commodities BLACK GOLD LOSES LUSTRE 14 February 2015

2 A PLUS According to the United States Energy Information Administration, in the third quarter of 2014 the most recent data the U.S. led global oil production with 14.2 million barrels per day. It was followed by Saudi Arabia with 11.7 million bpd and Russia with 10.5 million. China was in fourth spot with 4.5 million, just ahead of Canada s 4.4 million. Lower oil prices have produced mixed results for businesses: most report lower operational costs, but energy companies are struggling with shrinking revenues. A Plus looks at how CPAs can help take advantage of an era of cheaper fuel to maximize investment opportunities and create value February

3 Commodities Low oil prices seemingly good news for almost any economy are a double-edged sword. Countries that import petroleum can expect faster growth through higher spending by consumers, reduced input and transport costs for businesses and more flexibility for governments to pursue structural reforms. As Bob Partridge, Managing Partner, Transaction Advisory Services at EY China, notes: The big-picture, macroeconomic perspective is pretty positive. That is particularly true for net importers of oil, such as China, especially in a time of continuously slower growth. The Chinese economy stands to gain substantially from lower oil prices, points out Clare Howarth, Lead Asia Pacific Economist at Oxford Economics in Oxford, England. Real incomes are boosted, encouraging consumption, and industry benefits from lower input prices. However, a closer look reveals a downside: PetroChina, for example, is scaling down operations at its ageing Daqing oilfield in Heilongjiang province, potentially affecting thousands of employees. The company also cancelled a planned A$20 billion liquefied natural gas joint venture with Royal Dutch Shell in Australia last month. Countries that depend heavily on oil revenues, such as Iran, Nigeria, Russia and Venezuela, are in economic turmoil. For producers it s been relatively catastrophic for gross domestic product, says Kirk Williams, Managing Director and Oil and Gas Practice Leader at PwC China in Shanghai. Companies that provide products and services to support the fossil fuels industry are also facing difficulties, while alternative-energy businesses, such as solar panel manufacturers, are concerned that cheap oil will suppress investment in advanced technology. There is also a psychological impact of lower prices leading to reduced investor sentiment, says Xu Hua, Chief Executive Officer of Grant Thornton China in Beijing and a Chinese Institute of CPAs member. He points to a number of potential flashpoints threatening global economic stability, including the global oil price hitting the lowest level in five years, which dampens businesses confidence. Accountants are in a tough position to steer companies into consensus projections that inform optimal hedging strategies. The effects on Hong Kong s economy are more nuanced, experts say. Hong Kong is neither a consumer nor a producer on the world scale, Williams points out, adding that the city is also not a major global trading hub for oil futures. However, Hong Kong is home to a lot of commodity trading through banks and other institutions that generate more profits in a highly volatile environment. Generally, whether it is falling prices or rising prices it doesn t really matter, says Williams. The industry runs around and tries to hedge this stuff and make a buck on the market movements. Budget challenges For financial professionals, oil-price volatility makes it difficult to project costs with any confidence. Simon Booker, Lead Partner, Strategy and Economics, at KPMG China, notes that the spread of oil price outcomes for 2015 is as large as forecasters have seen. Some project a further reduction, while others see a rise to US$80 or more by year s end, he says. Accountants are in a tough position to steer companies into consensus projections that inform optimal hedging strategies. Accountants most directly affected are those working in the energy industry and its four major segments: upstream, such as exploration and production companies; midstream, such as transport and storage providers; downstream, such as refiners and petrochemical companies; and oilfield services, which covers such diverse providers as pipe and rig makers to helicopter services. There are more challenges in the valuation of inventory and cost of sales in oil-related transactions, due to the significant variation of prices compared to the beginning of the quarter, says Charlene Ng, Regional Finance Manager at Shell Marine Products in Singapore and a Hong Kong Institute of CPAs member. For those who have applied hedge accounting, the movements in and out of other comprehensive income accounts are likely to be much more frequent, Ng adds. More time and effort might be required to review and communicate the impact to non-finance colleagues for a better understanding of the underlying performance after HKFRS 9 Financial Instruments is applied, she says. Ng urges CPAs to reach an early upfront agreement with their company s management about the assumptions to be used when forecasting and planning budgets for the next year. Test the sensitivity under different oil price scenarios to understand how that will affect the overall performance in the financial statements, she recommends. Accountants in the Mainland could find themselves in unfamiliar territory, warns Michael Yap, Assurance Partner at PwC China in Beijing and an Institute of Chartered Accoun- 16 February 2015

4 A PLUS tants in Australia member, who recommends companies should consider scenario-based budgeting and rolling budgets, given oil pricing volatility. This is management accounting and that is maybe a new arena for Chinese companies to consider, says Yap, noting that some Chinese energy companies are particularly vulnerable to rapid change. Planning is done on a fairly rigid basis, he says. They don t set themselves up for a day or a month in advance but for five years ahead. Disruptive opportunities A weaker oil price environment in 2015 will crimp China s domestic crude oil production. Yap points to the cutbacks at Daqing as a sign of the times. A reduction from 40 million tonnes to 38.5 million tonnes is a drop in the bucket, but what strikes me is the willingness to reduce production, he says. While 1.5 million tonnes may not be a big number, certainly the conviction behind that is much bigger. Looking at a broader picture, Partridge at EY believes the oil price slump is a disruptive influence on economic activity and therefore an opportunity. This is a chance for the accounting profession to say that we are in a major state of disruption, he says. Are we repositioning ourselves, or are we waiting to be acquired or consolidated? As an example, Partridge points to how the slump has disrupted the global oilfield services industry. Last month, the biggest player, Schlumberger, announced it would fire 9,000 workers. The next two biggest companies, Halliburton and Baker Hughes, have announced plans to merge, but regulators in the United States have demanded that both companies sell off assets to comply with U.S. antitrust rules. At the same time, China needs to upgrade technological prowess if it wants to emulate the U.S. and develop its own shale oil resources, which are even tighter more difficult to access and are often located in arid This is a chance for the accounting profession to say that we are in a major state of disruption. February

5 Commodities If you are considering getting into oil, due diligence will make the crucial difference between striking black gold and making an expensive mistake. 18 February 2015 areas. (The hydraulic fracturing, or fracking, process used to extract such oil is highly water-intensive.) That, says Partridge, could present a strategic opening for Chinese companies that might be able to acquire technologically advanced assets at bargain prices. Clearly, private equity firms or high net worth family businesses with pools of capital are going to see good opportunities, he says. The Chinese government has also taken advantage of lower prices to accumulate higher-than-normal reserves, presenting scope for development of storage facilities. Tanks and storage is really an opportunity, says Partridge. Investment funds are already focused on that space. As well as private equity, sovereign wealth funds and specialist financial investment funds are also on the lookout for cheap petroleum-related assets. For those who want to get into the oil game, now is the time to buy, says James Fillingham, a Deals Partner at PwC in London and a member of the Institute of Chartered Accountants in England and Wales. Prices for oil industry debt, equity and assets are coming down fast. Uncertainty ahead More broadly, CPAs can use the breathing space offered by the current lower oil prices to position their company better in preparation for when prices rise again. The issue isn t dealing with low prices, it s dealing with

6 A PLUS Oil production breakeven prices The price at which the world s largest oil producing nations need to sell oil to balance their budgets. The current fall in prices is affecting many countries (US$ per barrel) Libya Iran Algeria Nigeria Venezuela Saudi Arabia Iraq Russia Angola United Kingdom (North Sea) United Arab Emirates United States (North Dakota)* Canada (Alberta) Qatar Kuwait United States (Texas) Canada (British Columbia) Norway *Q2, 2014 Sources: Deutsche Bank, Goldman Sachs, International Monetary Fund, Morningstar, Scotiabank, Sonangol volatility, Williams at PwC stresses. Fillingham, his London colleague, stresses the importance of conducting proper due diligence before making any investment. If you are considering getting into oil, due diligence will make the crucial difference between striking black gold and making an expensive mistake. He says investors should look closely at the portfolio of any investment being considered. Those companies working in fields where oil is particularly difficult to get at will inevitably become unviable sooner than those where the process is easier, he says. The more accessible wells will nudge back into profitability when oil prices do rise, as surely they will. No one is predicting when oil prices will rise again. I think it comes down to politics, says Williams, who describes the current low prices as due almost entirely to efforts by Saudi Arabia. The Saudis are pretty much doing this by themselves and it s a question of how long they can hold out against their friends, particularly Iran, Nigeria and Venezuela. The recent death of King Abdullah and the accession of his half-brother Salman to the Saudi throne are unlikely to accelerate any decision to cut back on production. A recent report by BP expects the Saudis, as well as the United Arab Emirates and Kuwait, to continue their determination to recapture market share from U.S. shale production. Ng from Shell Marine Products is not expecting stability anytime soon. Fuel prices will continue to be volatile and similar to prices of other commodities, she says, adding that she expects to see more fluctuations according to the macroeconomic as well as geopolitical factors in the external environment. Whichever way prices go in the future, CPAs will need to be on the ball. You will need to be much closer to the market and you need to have a budget that is able to respond to signals and strategies, says Yap at PwC. I think it forces companies to think very carefully about their capabilities and harness their strengths. You need to make a CPA and management response because you are dealing with an uncertain economic situation. February