Oil and Gas Majors trying to be competitive in a structurally lower price environment
It is an economic reality that when commodity prices are high and margins are healthy, resource companies are encouraged to develop new supply. Besides the obvious rationale of taking advantage of high prices at the time, it is also easier to attract funding when margins are large as these wide margins give funders, both equity and debt, a margin of safety. The problem near or at the top of the cycle is the so called “rent seekers” also want their share of the “super” profits. Rent seekers can be governments, employees, consultants, manufacturers, suppliers and construction companies and they adjust their price expectations upwards thanks to good margins resource companies are earning. Over time as these expectations are met, the returns for the ultimate risk taker; the resource owner and the funders, may be much lower relative to the amount of risk taken. This process of changing resource prices and the resultant profits contribute to the cyclical nature of the resource industry. Resource companies always over invest at the top of the cycle and underinvest at the bottom of the cycle thereby increasing the volatility of cycles compared to other parts of the general economy.
But what happens when the fundamentals of the industry change after long periods of price stability?
Director - Research