A Balanced View: Introduction to Oil and the Energy Industry

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Introduction to Oil and the Energy Industry by Sui Chuan, ValueEdge

The fall in oil prices have been hogging business news in recent weeks. Prices of oil counters have plummeted accordingly, with some currently trading at single digit historical P/E. From a value perspective, the most important question is whether low oil prices are here to stay, especially with the advent of shale gas. Not everyone would be familiar enough with the industry to make a sensible judgement (including us). As such, we thought it might be useful to present the results of our fact-finding research, and leave the judgement up to you.

Historical Oil Prices

A snapshot of oil prices in the last 50 years. These are adjusted for inflation based on January 2014 prices. A graph alone is hardly useful; here are some figures that you should note.

Oil, Energy industry

Energy Industry

When we talk about oil, we are actually referring to the petroleum industry. The petroleum industry is just one of the many industries that make up the energy industry which also includes the gas industry, coal industry, electrical power industry, nuclear power industry and renewable energy industry. There is a slight overlap as the electrical power industry is dependent on outputs from the gas, coal and petroleum industry for fuel as well. Therefore, if we were to dissect the energy industry based on a supply of fuel types, I believe we can safely omit the electrical power industry from the picture.

Oil, Energy industry

In terms of global energy consumption, oil remains the world’s leading fuel. However, the market share of oil has declined for 14 consecutive years, with its current market share the lowest since British Petroleum (BP plc (ADR) (NYSE:BP) (LON:BP)) started its data set in 1965. 2 questions here – what drives energy consumption, and what drives oil consumption? We will tackle the latter in the subsequent section.

Unsurprisingly, energy consumption is driven predominantly by economic growth as all economic activities require energy whether it is for transportation or to run machines. In 2009, world energy consumption decreased for the first time in 30 years, by ?1.1 as a result of the financial and economic crisis, which reduced world GDP by 0.6% in 2009. Growth in energy consumption is dominated by emerging economies, accounting for 80% of growth in 2013 and nearly 100% of growth over the past decade according to BP.

Petroleum Industry

Oil, Energy industry

While oil remains the world’s leading fuel, it only accounts for about 4% of electricity generation. Instead, it used more often for transportation and industrial uses. It is also the raw material for many chemical products such as solvents, fertilizers and plastics etc. According to the U.S Energy Information Administration, the transportation sector accounts for the largest share of total consumption (72% in 2013). The decline in oil consumption, as mention earlier, has been attributed to improvements in vehicle efficiency and increased production of natural gas which is a supplement to certain types of fuel oil.

The petroleum industry is divided into 3 major components: upstream, midstream and downstream.

  1. Upstream

The upstream segment is involved in the exploration and production of crude oil. This space has been dominated by National Oil Companies (NOC), as opposed to International Oil Companies like Chevron Corporation (NYSE:CVX) or Exxon Mobil Corporation (NYSE:XOM), in recent years which control the rights over the largest oil reserves. These are the companies which order oil rigs from companies like Keppel, Ezra and Ezion etc. However, there are 3 kinds of oil exploration – offshore, deep water or shallow water drilling – and different oil rig companies may have their own specialty. For example, Nam Cheong is one company that specialises in shallow water rigs. In general, the trend deep water drilling is expected to increase as supply from shallow waters continues to dwindle. However, the disadvantage is that deep water projects are more expensive with some projects requiring up to $85 per barrel to be economically viable. Here is the list of the top 10 largest oil companies by reserves, taken from Wikipedia

Oil, Energy industry

2. Midstream/Downstream

Midstream operations are usually included in the downstream category. Together, they include the processing, transportation and storage of petroleum products. In 2012, the top 10 midstream companies are as follows:

Oil, Energy industry

Final words

There are many other factors to consider – some geopolitical in nature – and we have only skimmed the surface in this article. However, we hope that this can serve as a beginning for anyone who is considering making plays on oil’s recent fall in price.

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