Lower Crude Oil Price Regime: Boon for UK Economy While A Setback for Upstream Companies 

The unprecedented drop in the international crude oil prices is a nightmare for the upstream oil companies. These are the companies who offer crude oil as the final product to their customers. However, a sharp slump in the oil prices may be good for UK economic health, as a massive fall may trigger overall economic activity in Britain and elsewhere. A shrinking oil price scenario reduces the cost of production for businesses, especially for those that are heavily dependent on oil inputs, which will consequently boost both investment and employment at the same time. Amid oil price war, which was invoked by Saudi Arabia, sectors like agriculture, air transport, coke and refined petroleum manufacturing and oil-intensive manufacturing sectors will benefit, as the price of their crucial input falls.

Saudi Arabia began an oil price war with Russia by slashing oil prices by $6-8/bbl. Earlier, Russia refused the proposal of Saudi Arabia for a further oil production cut to strengthen oil prices. Hence, in retaliation to Russia decision of refusal for oil production cut proposal brought forward by OPEC members, Saudi Arabia started the oil price war by reducing its official oil selling prices for the crude grade to all destination by $6-8/bbl (as per the media reports). Following this move, the Brent crude oil futures nosedived by more than 32% on a Monday, 9^th March 2020 trade, the biggest one-day fall since Gulf War in 1991 and traded at its lowest level since February 2016.

Also, Saudi Arabia announced that it will ramp up production to 10 mbbl/day from present 9.7 mbbl/day and also notified that it could reach a production level of 12 mbbl/day amid lacklustre demand for oil globally, earlier because of US-China trade war and now because of the outbreak of the deadly COVID-19 across the globe.

Oil companies in the oil and gas industry are typically divided into three segments, i.e., upstream, midstream and downstream. Upstream companies are those who are involved in the exploration and production of oil and gas. Companies like Premier Oil PLC, Tullow Oil PLC, Cairn Energy PLC, Energean Oil & Gas PLC, Pharos Energy PLC, and EnQuest PLC are among the London Stock Exchange-traded companies which are pure-play upstream businesses, and their operational interest lies solely in exploration and production of crude oil.

Midstream companies’ activities include processing, storing, transporting and marketing of oil and downstream companies are those who are engaged in refining crude oil to convert oil into finished products like gasoline, diesel, and other petrochemical products. Also, there are integrated oil & gas companies, as they blend their upstream businesses activities with midstream and downstream business activities. Royal Dutch Shell PLC and BP PLC are the only integrated oil and gas businesses listed and traded on the premium market segment of the London Stock Exchange.

So, for upstream companies’ crude is the final product offering, hence higher the oil price, higher the revenue, income and profits which in turn increases shareholders value; however, a lower oil price directly weighs on these companies top-line, which drag their income and profit together.

However, for downstream companies' as crude oil is the raw material, lower the oil price it leads to lower the cost of their production, which in turn increases income and profitability at the same time for these businesses. That's why integrated oil and gas majors like Royal Dutch Shell PLC and BP PLC would have a mixed kind of impact of the oil price slump, as they are into upstream as well as downstream businesses both.

No doubt their shares have also plummeted on the London Stock Exchange, but it was not in the same proportion as of the pure-play upstream companies like Premier Oil PLC, whose shares plummeted more than 70% in the last five trading session, Tullow Oil PLC (down ~50% in the same time), Cairn Energy PLC (down 47%), Energean Oil & Gas PLC (down 40% ), whereas shares of Royal Dutch Shell PLC plummeted 20% in the last five trading session and BP Plc shares slumped 20% as well during the period under consideration.

On an average performance basis, the upstream company’s shares are lower by approximately 47% in the past five trading sessions on the London Stock Exchange, whereas integrated oil company’s stocks are down 21% on an average, during the same time period. The relative outperformance of Integrated oil companies against the pure-play upstream companies is approximately 26% in the last five trading sessions.

(Source: Thomson Reuters)

Falling oil prices could boost overall employment level in the UK and prosper the economy

A drop in oil prices would have a likely positive impact on overall employment level in the UK economy, which is directly proportional to the increased levels of economic activities. A potential spurt in the productivity and profitability among the UK businesses which would come from significantly lower oil prices will lead to increased demand for labour and capital, which will push the wages and return on investments. Also, a higher wage income in the economy attracts more workforce into employment and ultimately, the general income level increases, which is very crucial for any economy to prosper in the long run.

Also, it seems that the Kingdom’s move to slash oil prices and ramp up production would lead to an oil price war that could last for several weeks, months or even for years until a compromise on the resumption of production cuts is agreed between OPEC members and Russia.

So, this is going to be a good time for both, the company's whose dependency on crude is higher as raw material and for the overall economic health of the UK.