Oil Market Overview

After oil price has almost doubled in value from the start of the year 2007 and has been repeatedly renewing its historical maximums this fall, therefore it is really worth to examine the underlying reasons of the rapid growth and the possible influence on oil sector companies.

The upward trend for oil price started early in January 2007 after it had reached its local minimum with the price of 56$ per barrel. Then oil price grew steadily up to 75$ until the end of the July, and after a little correction happened in August, it has rocketed during the autumn to the level of 99$. (Figure 1). Now investors are in expectation of price to overcome strategically and symbolically important level of 100$ per barrel. There are little doubts among oil market analysts whether this overcoming will happen; the only question is when. Therefore a good question will be: why actually there are such strong bullish dispositions in oil market this year? And there are several reasons for this.

Figure 1. Light crude oil price chart for the past 12 months (nov. 2006 – nov.2007)

Source: Trading charts

First reason to the oil price increase was the fall of dollar against all other leading currencies. The fall was caused by the declining economic situation in the USA, especially in housing sector. Basically, while oil price in dollars was rising, and dollar was falling at the same time, the increase of oil price expressed in other currencies was not so significant.

Second factor is the slowed growth of oil supply and as the result low oil inventories. Main reason for that is the unstable situation in some of rich in oil regions. Especially, it concerns the Middle East. Ceaseless war in Iraq, pressure of the US and the world society on Iran because of its nuclear program, instability in Saudi Arabia – all that led to cut downs in short-term supply.

Third factor has a financial background; however, there is no straight proof for its existence. It was noticed that even in the days when lots of potentially price decreasing information about oil was issued, oil price increased nevertheless. And now many specialists believe that it can be explained by the fact that major investors were and still continue speculating with oil futures, thus making the oil price artificially go up.

However, these are not the only factors which influenced the oil price. In some days it was affected by nature cataclysms such as hurricanes, earthquakes etc. and also by corporate news of world leading oil producers. Moreover, growing demand from emerging markets should be mentioned.

Increasing oil prices are generally harmful to society as they increase costs of most goods’ production and as the result prices for these goods go up. Thus people have to spend more of their income on the same amount of their consumption, in other words their real income decreases. But not everyone is harmed; there are also those who benefit from oil price growth. These are so-called oil sector companies, which are involved in oil production and transportation. Profits of such companies are dependant on price at which they can sell their main product.

As this year the situation in the world for oil companies was favorable, their profits as well as the other financial ratios have increased considerably. That in its turn became a signal for investors to put up their money in oil industry.

There are several reasons which can explain how positive financial figures influence on decisions to invest. First of all, high profits mean that most likely high dividends will be paid to shareholders at the end of the year, so becoming one of them is really tempting. Second, by profits, companies receive extra funds, which can be spent on their further development, including market position strengthening, and market share’s extension, and as the result in foreseen future investors may expect even higher profits and of course higher dividends. Thirdly, realizing that positive financial information about the company increases the demand for its stock; many investors will simply open long positions on oil companies’ stocks in order to earn money on speculations.

So what can be derived here after all the arguments are discussed is that stock value of oil companies sufficiently dependant on oil price. If oil price increases, the stock value of oil sector companies is to increase.

In our case it will be interesting to consider the behavior in oil sector at Russian stock exchange. (There are almost no oil producers in Sweden, Finland and Baltics). Market movements in two situations were analyzed: the stock value of Russian leading oil producers during the oil rising trend and during the oil falling trend. Changes are illustrated in Table1.

Table 1 Oil and Russian oil sector companies’ stocks price comparison

As it can be seen from the Table1, stock values were not just moving in the same direction as oil price in both periods, but even slightly differed in percentage changes. The period 1.12.06-16.01.07 when oil dropped in price by 20% is even more interesting than the second one, as usually there is a rally happening in December when everyone is willing to buy stocks just before the dividends are paid. But that has not worked in the oil sector, where companies followed the oil price trend and also dropped in price. The second period 22.08.07-07.11.07 is roughly the same as the first one, but movements happened in opposite direction.

Basically those who are willing to invest in oil sector companies should be aware of what is happening at oil market, and only then make any decisions. However, there should be also taken into consideration the fact that oil price is not the only factor which influences the oil sector stocks’ values. Other factors can be also some political decisions concerning the company, corporate news like changes in company’s structure, acquisitions of other small companies etc. That is why for example, in the second period JSC Rosneft increased by only 15%, whether JSC Tatneft by 31%.

Finally, there should be said that most of analytics expect oil price to increase even more in future, and it is one of the reasons why investing in oil sector companies is rather perspective.