Once the darlings of the speculative investor, oil exploration and mining stocks have fallen from grace in recent years as the oil price and commodity prices in general have declined sharply. The persistent weakness in the oil price has led to sharp under-performance in the share prices of the major integrated oil companies as well as the smaller exploration stocks.
As the table highlights, sectoral indices in Ireland, Britain and the US exhibited declines of 3060 per cent during 1998. The reason for such a sharp fall in oil company share prices is not hard to find in the precipitous fall in crude oil from close to $20 (€17.90) per barrel in 1997 to the current level of around $11 per barrel.
Three key factors were behind the creation of an excess supply of oil on world markets that caused this sharp fall in the oil price. The first, and probably most important, was the crisis in Asia which led to a sharp reduction in oil consumption in what had been a fast growing region. A second factor was an expansion in Iraqi oil exports under the UN food-for-oil barter arrangement and the final nail in the coffin was the warm winter weather experienced during the first half of 1998. Lower demand and increased supply of oil led to a build-up in inventories and persistent downward pressure on the oil price.
The deterioration in the oil price was exacerbated by the slow response from the Organisation of Petroleum Exporting Countries (OPEC) to respond by cutting back on its oil output.
OIL PRICE $ PER BARREL (Brent)
1997 - 19.3
1998 - 13.1
1999 - 11.0
Resource Indices - Return 1998 %
FT Exploration & Production - 61.0
S&P Oil & Gas Index - 32.9
Davy All Resource Index - 60.2
Where is the oil price likely to go in coming years? Analysis of the oil price involves as much political analysis as economic analysis. Economic factors alone would point to the oil price remaining weak for a prolonged period due to slow global economic growth and a glut of supply. For the low-cost producers of oil the marginal costs of production are $5 or lower so that even at current prices it can be profitable for them to increase supply.
However, a very low oil price would ultimately result in the developed world being very dependent on Middle Eastern supplies together with an attendant decline in its own onshore and offshore oil fields. Indeed, if current oil prices persist for a prolonged period of time there will be very little oil exploration in the higher cost developed world.
Oil prices have declined in the past to current levels but quickly rebounded. In 1986, a barrel of oil touched $10 but quickly recovered in 1987/88 primarily due to rapid growth in Asian demand. In the absence of a sharp recovery in Asia the oil price is likely to remain low for the foreseeable future. However, the political imperative of ensuring long-term diversified sources of supply should lead to a rising price over the medium term. For investors, this probably means that it is best to continue to avoid the pure exploration companies but to consider investing in the integrated oil majors such as BP/Amoco and Royal Dutch/Shell.
