Investing for the Oil Price Collapse (Part II)

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The upstream sector of the oil industry will naturally suffer, as lower oil prices translate into lower profits, but without a precise one-for-one correlation. Taxes and royalties absorb much of the oil price around the globe so that oil producing governments in effect absorb much of the price risk. The larger companies will usually benefit relative to the smaller ones, having deeper pockets, and the relative debt levels will be an important indicator of performance after prices drop.

The stock market will almost certainly benefit from expected improvements in consumer confidence and spending, as well as a lowering of inflationary pressure. Broader indices are thus relatively likely to climb, while bonds might benefit from lower inflation. The dollar might move the price of oil lower when it strengthens, but lower oil prices should also help to firm the dollar, as the U.S. trade balance improves.

The upstream sector of the oil industry will naturally suffer, as lower oil prices translate into lower profits, but without a precise one-for-one correlation. Taxes and royalties absorb much of the oil price around the globe so that oil producing governments in effect absorb much of the price risk. The larger companies will usually benefit relative to the smaller ones, having deeper pockets, and the relative debt levels will be an important indicator of performance after prices drop. A new round of acquisitions is likely, as the healthy larger companies absorb some of the smaller ones with poor cash positions.

One factor to look for in assessing how well companies will ride out lower prices is their exposure to inflexible fiscal regimes. This is involves an assessment of the political situation more than of the contract structure, as some governments are quicker to modify excessive taxes than others. In particular, countries like Iran and Venezuela tend to be very slow to react, while Alberta, Algeria and the UK are much more reasonable. Smaller, more economically vulnerable producers can be expected to revise their terms quickly in order to maintain investment and production flows.

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