Posted on April 8, 2009 - by Market Uncle

I bought Singapore Petroleum Company on 27th March 2009

Rationale

Ever since the crude oil prices hit around US$ 30 sometime ago (from a record high of above US$ 140 last year), I believe the business fundamentals for oil companies (e.g. SPC) have made a U-turn.

There are a two main sources pressuring their income statement:

1. Inventory write down (declining oil prices)
2. Declining revenue (from falling demand and refining margin)

Given the speed at which crude oil prices had collapse by Dec 2008 (around US$ 40), the inventory write down should more or less been completed by the last FY report, ending 31st December 2008.

While demand will take some time to recover, the downside will be limited given current widespread dependence on crude oil for basic subsistence.

I could have bought it earlier, when SPC share price languish slightly above $2, but spare cash is a rare commodity nowadays and it is only recently that I am able to scrape enough to buy some.

Potential for more inventory write down

Oil prices trends

The following is the crude oil future contract compiled from Energy Information Association:


For a relatively long time in modern history ( 1986 to 1999), the world seems contented with crude oil around US$ 20. Assuming an inflation rate of around 3% to account for rising living standards (greater convenience in life centred around electricity use and motor transport) and adding another 1% for world population growth, the resultant stabilised oil price is still about US$ 30 (9 years from 1999).

Cutting supply to boost prices?

The following chart is also compiled from Energy Information Association:

Despite a few relatively small crisis, Asian financial crisis in 1997/98 and SARS in 2002/03 (compared to the present) from 1997 to present, there was no notable cut in supply even though prices took a sharp dip (see oil futures chart above) in both periods. In fact, supply continue to grow steadily over the years. Cutting supply to boost income doesn’t really make sense unless the surge in price is sufficient to offset the (promised) plunge in volume. Since the volume normally does not drop as much as promised, the price is not boosted as expected. On the contrary, if demand continue to drop, the oil producers instead have to increase production to sustain their income, more so in a bearish oil market.

Taken together, the potential inventory write down in coming quarters is still material but not as significant as when the crude oil price was above US$ 100 per barrel.

Declining revenue
Read more…

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