If theres one topic that has dominated the financial world for much of the past month, its the falling price of oil. Indeed, from a high of $115 per barrel reached overthe summer, the price of Brent crude has slumped during October, falling morethan 26% in only a few weeks. Unsurprisingly, the falling oil price has worried investors in the sector, but some oil companies are better placed that others to weather the storm.
Balance sheet issues
Embattled African oil mid-capAfren(LSE: AFR)is one of theoilsectors most risky bets. After sacking a larger portion of its management team earlier this week, Afren appears rudderless. Whats more, City analysts have now started to express concern about the state of the companys balance sheet. Specifically, Afren needs to refinance its banking facilities next year and lenders could be reluctant to give the company more cash as the price of oil falls.
Nevertheless, a bid for the company could be on the cards asSouth Atlantic Petroleum Limited, a privately held Nigerian oil & gas exploration and production company, has gobbled up around 7% of Afrens stock during the past few weeks.
North Sea producerEnquest(LSE: ENQ) is also likely to be struggling in the current environment. According to the companys half-year results released at the beginning of August, Enquests total operating cost per barrel of oil produced during the first half of the year was $72.5.
With oil currently trading below $86 per barrel, Enquests profit margins have become razor thin and the company could be forced to scale back spending plans in order to save cash. Still, management seem optimistic with several directors boosting their shareholdings at the beginning of October.
While Enquest is under pressure from high production costs, Gulf Keystone Petroleum(LSE: GKP)is struggling with low selling costs. According to my figures, based on numbers issued by Gulf Keystone itself at the end of August, the company is currently selling its oil into the domestic Kurdish market at a price of$42.72 per barrel, more than 50% below the Brent benchmark. Its reasonable to assume that with the price of oil slumping, the price achieved per barrel of oil sold by Gulf Keystone has declined by at least a few dollars per barrel.
For a full run down on Gulf Keystones current trading and prospects, stay tuned for my interview with Gulf Keystones management next week.
You see, a large part of BPs and Shells business is refining. Theserefining operations help soften the blow of falling oil prices because the downstream operations, which refine oil into gasoline and other products, become more profitable when the oil they use is cheaper.
For example, for every $1 improvement in theprofit margin for refined products, BP generates an additional pre-tax operating profit of $500m. According to BPs management the current refining margin is $5.70 a barrel higher than it was this time last year. Shell is likely to profit from an expanding refining margin as well.
Not all good news
Unfortunately, its not all good news for BP and Shell as while downstream refining profits are rising, City analysts estimate that Shell and BP need the price of oil to stay above $85 per barrel for their current operations to break even. As I write this the Brent oil price stands at $85.91 per barrel.
Still, both Shell and BP have stated that any new projects they commission must have a maximum break even production price of $75 to $80 per barrel. So, the two companies are keeping a lid on costs across the board and over the long term the two oil behemoths shouldcontinue to profit.
Strict cost controls and capital allocation are two of the reasons that have enabled BP and Shell to become two of the world’s largest oil companies. Moreover, keeping costs under control has enable Shell in particular to maintain and increase its dividend payout every year since the end of the Second World War, that’s a record few other companies can match.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.