A LOOK BACK IN 2014: What will 2015 hold for CEE oil & gas sector?

The sharp fall in oil prices in late 2014 strongly pulled down the shares’ market price of the companies in the oil and gas sector in Central and Eastern Europe. The toughest times are not yet over for the relevant industry in CEE: financial results for last year are soon to be released, results that will include the oil price evolution in the Q4 last year, i.e. the very period when the oil price registered the steepest fall. And, as it happens in a context where pressures on the oil market will continue to manifest in 2015, both these companies and stock exchanges and investors will have lots of challenges.

historical-evolution-of-oil-prices2014 brought to the stock markets the second largest downward movement in oil prices in the past 50 years. In this latest half a century (for this period there is an official and credible historical stock exchange lists) only the fall by almost 70 percent in 2008 (when the oil listing fell from USD 130 to USD 40 dollars per barrel in the second half of the year) exceeds the one registered last year. Thus, after a period of about two and a half years when the oil was traded with smaller or larger variations around the threshold of USD 100 per barrel (since 2011 - as it can be seen in the chart ‘Historical evolution of oil prices’, and up to the middle of last year), oil prices reached in December 2014 the level of USD 50 per barrel, describing a decline of over 50 percent. It should be noted that the largest part of this decrease occurred during the second half of the year (the decrease began in July - as can be seen in the chart ‘Evolution of oil prices in 2014’); and the maximum speed, or amplitude, on the slope of the falls was recorded even in the fourth quarter; i.e. only during the months of October, November and December, an interval during which, relative to the values at the end of 2013, oil prices have marked an average decline of over 40 percent.


Following such a shock, the world’s capital markets could not remain insensitive. In their turn, stock indexes recorded decreases - more or less extensive, depending on the number and weight of oil and gas companies in their structure, but also according on the geographical area covered. But if the general indicators (reflecting the overall evolution of a basket of companies representative for the entire national or regional economy) have experienced a relatively moderate impact - because decreases of companies in the oil and gas sector were offset by the positive developments of companies from other sectors... the stock indexes reflecting the development of oil and gas sector (either on national or regional level) received the full blow; the power of these blows was directly proportional to the weight, importance and the number of companies with problems included in the respective indexes. It can be seen that the negative effects had a relatively small extent in the relevant indexes for the economically developed areas, but had an extensive enough influence on the indexes in which Russian companies have a share and a greater relevance, as in the case of indexes relevant for the evolutions (sectoral and general) in Central and Eastern Europe.

the-evolution-of-prices-in-2014Thus, taking into consideration the Stoxx 1800 Oil & Gas index – an index reflecting the overall evolution of the oil and gas sector for the developed economies (as a basket of shares of the oil and gas companies in these economies), it can be seen that, after a long period of side development, with modest positive and negative variations at around 470 points, it began to experience, since September 2014, the reverberations given by the increasingly steep declines in oil prices. From that very moment (September 2014), the Stoxx 1800 Oil & Gas index recorded a downward trend during which, along that baleful last quarter, it lost 10 percent of its value. In contrast, the general index Stoxx 1800, which reflects the evolution of a basket of shares of the most important 1800 companies in all fields, in the developed economies (thus offering an overview on the evolution of the economy in these countries) recorded by year end, on the whole last quarter of 2014, an increase of about five percent (see the chart ‘Evolutions in the developed economies’). The steep drop in oil prices in the last quarter of last year, during which global oil listing fell by over 40 percent, had a stronger influence on Stoxx 600 Oil & Gas index’s evolution; an index that reflects the evolution of the oil and gas sector in Western Europe, which fell in the same time frame by almost 19 percent. For comparison, in the last quarter of 2014, the Western European economy as a whole (evolution reflected by the Stoxx 600 index – which includes shares of the 600 most important companies in all sectors in Western Europe) had managed to register a relatively balanced trend, recording a 0.2 percent deficit; the rest of the economy thereby offsetting the negative pressure coming from the decreases in the oil and gas industry (see the chart ‘Evolutions in Western Europe’). The fall in oil prices worldwide however, had the strongest effect in Central and Eastern Europe, where the effects were significantly stronger transmitted both in the overall index which reflects the evolution of the economy (Stoxx 300 - which includes shares of the largest 300 companies in the region, in all fields) and at the sectoral level. Thus the profile index, Stoxx 300 Oil & Gas, recorded in Q4 2014 a decrease of about 28 percent, while the parent index, Stoxx 300, lost nearly 19 percent (see the chart ‘Developments in CEE’). The broad correction was determined mainly by lower oil prices, but on the other hand seriously enhanced by a number of other influencing factors. These additional factors of influence include the complex situation given by the fact that many companies (and perhaps the most important ones!) in the Stoxx 300 Oil & Gas index are Russian companies that suffered heavy blows not only from the fall in prices (of oil and gas) but especially from the sanctions imposed by the US and the EU - sanctions that limited both their access to international markets financing and their access to the latest technologies and techniques in the field.

evolutions-in-the-developed-economiesBesides, these differences, given by the specificity of the economies where companies included in one index or another operate and given the specific problems and challenges each entity faces, explain the differences of market price evolutions of the companies in the field in CEE. Thus, as it can be seen in the table ‘Winners and losers in the oil and gas sector in CEE’, in the top, registering the largest decreases of shares’ prices on the market, there are many Russian companies - such as Rosneft, Gazprom and Novatek (with drops of 15 to 25 percent during 12 months); for comparison, apparently paradoxically, the highest market price depreciation over the four quarters that ended in September 2014 were recorded by companies such as OMV and MOL.

There are companies that didn’t have to deal with the same challenges as the Russian ones (which suffered directly as a result of the western sanctions), but whose business prospects are strongly deformed by a possible (and predictable!) continuation of the European policies aiming at remodelling (and reducing) of the relationships (and dependency!) of the European economy on Russian gas and oil. developed-economiesdeveloped-western-europeTherefore there were various kinds of pressures which the companies in the region had to face. And the list does not end thereof: thus, as another example, answering questions submitted by the Petroleum Industry Review, Goran Saravanja, chief economist of the Croatian group INA-Industrija nafte d.d., said: “INA had faced many challenges in 2014. Our refining operations locally continued to accumulate losses due to the revocation of the majority of our concessions, following a state decision in 2011. We were also exposed to serious financial losses due to unexpected changes in the regulatory framework. We had to pay retroactive taxes on refineries’ domestic consumption, state royalties have doubled, we were compelled to sell the company’s gas reserves and, following a change of the legal framework, the retail distribution segment was taken over by a state company”. It’s worth noting in this case the fact that, despite receiving some extremely powerful blows, the Croatian company INA still managed to achieve in the first nine months of 2014 a growing profit by about 19 percent (approx. EUR 76 million) against the one reported for the same period last year (EUR 64 million). Beyond the issues mentioned above, regarding the effects of other types of external inputs, both on shares prices and on the financial results after nine months, it is clear that the fall of the oil prices in the second half of 2014 has sent strong reverberations worldwide. And especially on the evolution of the oil and gas companies’ listed on the stock exchanges; making a comparison between the indexes, we can say that these effects were reabsorbed in part and gradually on their way from outlying areas to the epicentre of the global economy - an epicentre represented by the developed countries.

This type of propagation, with stronger effects in peripheral areas and weaker in developed economies is not only a result of falling oil prices but also derives from particularities of the companies in the index composition; the differences in the magnitude of the effects were also influenced by the structural particularities or by the regulating frameworks in the economies where the companies are involved. Strictly related to the negative trend in oil prices, however, it is clear that in developed economies, where economic mechanism is complex, the negative effects of lower oil prices may be counterbalanced by the rest of the economy, at least partially, by a possible future enhancement of demand.

graphic6In contrast to the companies in the emerging world, the negative effects of decreasing oil prices were and are often exacerbated by other specific phenomena of the respective economies - such as changes in the regulatory framework, domestic currency devaluation, reducing the share of international market profile or, not least, increase of financing costs needed in order to maintain liquidity flows and investments.

Specifically, we can say that, if referring to Stoxx 1800 Oil & Gas index, the amplitude of the corrections was tempered by the fact that cheaper fuel can be an engine for economic growth and thus an incentive to increase demand; unlike it, in the case of Stoxx 300 Oil & Gas index, tensions induced by the decline in oil prices were amplified into the market price of some of the companies in the index (i.e. - the market price of Russian companies!) due to specific problems they face as a result of sanctions imposed by the West and to the massive depreciation of the domestic currency.


The charts reveal the fact that, globally, in developed economies, companies in the field have already cashed in, in the market prices, part of the shock of the decrease in oil prices during the fourth quarter; general indicators sensed this, as it was otherwise normal, in a significantly lower extent than oil and gas sector indexes. The latter ones took, in their turn, differently the reverberations of the fall in oil prices, depending on the economic conditions specific to each area. Therefore, of all the three mentioned indicators, given the specific area, the index of the oil and gas sector in Eastern and Central Europe is not only the most affected so far, but also one that is facing the biggest challenges in 2015. This is because the evolutions of the index up to the end of last year were the result of only a first round of effects, determined by expectations, estimates or anticipations coming from investors and analysts on the future of the companies within. Estimates whose scenarios, from a fundamental perspective, are based on the published financial results for the first nine months of the year and the evolution of oil prices in the fourth quarter - their assessments are more or less realistic. And, as far as the published figures of some companies have not yet incorporated the oil price evolution in the fourth quarter, i.e. the worst time for the global market, countless surprises may occur.

graphic7Altogether, at this moment, one can see that, for the first nine months of 2014 (as shown in the financial reports at the end of Q3) business activities of the companies in the CEE sectoral index were preserved, as they reported higher incomes than those reported for the nine months of 2013. Thus, as shown in the table ‘Growing incomes’, half of the companies included in the Stoxx 300 Oil & Gas index recorded sales revenues increases; four of the Russian companies in the index recorded revenues increases of over 20 percent (Rosneft, Novatek, Gazprom Neft and Surgutneftegas). During the same interval, the other half - companies that have registered falling revenues in the first nine months of 2014 - have had in most cases insignificant variations; only five of them registered falls in revenues of over five percent (with a maximum of 10 percent decrease, in the case of Transneft).


On the other hand, the profit figures for the first nine months of the year, although noticeably affected, are not terribly bad. As one can see in chart ‘Profits hit by falling prices’, there are not at all few companies that, in the first nine months of 2014, have seen their results increased. In a standing ran according to the percentage change of the profits in September 2014 to September 2013, we can see impressive increases for MOL, Transgaz and for the Turkish company Dogan Holding (see the chart ‘Profits hit by falling prices’). Furthermore, things were not so bad neither for some of the largest Russian companies in the field: e.g. for nine months in 2014 as against nine months in 2013, Surgutneftegas’s profit increased by 87 percent, Novatek’s profit increased by 19 percent, while Tatneft’s profit increased by 14 percent. It is true that another important part of the Russian ‘heavyweight’ companies in the index were placed at the opposite extreme. Among them, Transneft, Gazprom OAO, Rosneft and Lukoil, whose profits fell in nine months of 2014 by 20 percent to 35 percent.

graphic8Divergent developments can be noticed also for other oil and gas companies in the region, whose shares are not included in the regional Stoxx 300 Oil & Gas index. As it can be seen in the chart ‘Other financial results in the region’, while the Romanian company Romgaz reported for the first nine months of 2014 a profit of about EUR 252 million (compared to EUR 178 million recorded in first nine months of 2013), the Austrian company OMV’s profit halved in the same interval (EUR 665 million) and recorded a spectacular fall in revenues (from EUR 32 billion to EUR 28 billion), while the Slovak company Slovnaft went from profits to losses, recording significantly reduced incomes.

These trends should worry the financial markets and the investors. This is because the variation in profits for the first nine months of the year, when the decreases in the oil market were not the most spectacular, is a signal that the market would toughly experience the decline in oil prices in the last quarter of the year. The question mark remains only on the magnitude of these effects and the degree in which they are expected, being already included or not in the market prices.


The situation is even more disturbing as the beginning of 2015 hasn’t showed good signs and oil prices continued to fall heavily. Thus, only until the end of the second decade of January, the WTI oil price (US reference) fell by about 14 percent, from USD 54 per barrel (in late 2014) to USD 46 per barrel, while the price of Brent crude oil (reference for Europe) fell by 15 percent, from USD 55 to USD 47 dollars per barrel. The negative outlook for the industry, given by the evolution of oil prices early this year, is confirmed by experts in the field. Thus, according to the latest report ‘Short-Term Energy Outlook’ released by the EIA (Energy Information Agency - an agency of the US Department of Energy) on January 13, 2015, the quantities of oil inventories held worldwide will continue to increase, which will put additional pressure on the prices.

graphic9According to that report - which is the first report with forecasts for 2016 - the average price of Brent oil will drop to USD 58 per barrel, about USD 11 below the previous estimations (issued in December). The EIA forecasts, however, show that the price of Brent oil will trade in January and February at lows of about USD 49 per barrel; after reaching these thresholds, according to those projections, prices will go on an upward trend, so that in the last quarter of 2015 will reach an average of USD 67 per barrel, and in 2016 the average price will be of about USD 75 per barrel.

The analysts of reputable financial institutions have also proceeded to spectacular revisions of previous estimates. The US investment bank Goldman Sachs has reduced its estimate for Brent oil price for Q1 2015 by half, from USD 80 per barrel, as it was the previous estimate, to USD 42 per barrel. Also, for the first half of 2015, the Brent oil price estimate was reduced by Goldman Sachs analysts from USD 85 per barrel (the previous estimate!) to USD 43 per barrel, and for the year 2015 from an average of USD 90 per barrel to USD 70 per barrel. As far as the WTI oil is concerned, adjustments were similar in magnitude: from USD 75 to USD 39 dollars per barrel for the first six months of the year and from USD 80 to USD 65 per barrel for the entire year 2015.

The same major revisions for oil price for the next period and an even more pessimistic perspective is found in the Société Générale reports - one of the largest European players in the field. According to the French bank analysts, the average price of WTI oil for 2015 would be approximately USD 51 per barrel - significantly adjusted against the level originally estimated, which had been of USD 65 dollars per barrel; estimations for Brent oil in 2015 point to USD 55 as against USD 70 per barrel in the previous forecast.

Somehow more optimistic than the French bank specialists, for all of 2015, are the Austrian Raiffeisen Bank analysts. According to them, the average oil price this year will be of USD 58 per barrel (and of USD 77 per barrel in 2016) - and in this case, however, one can observe a massive adjustment to the previous forecast, which was of USD 80 per barrel (USD 90 per barrel in 2016).


The first thing that stands out for most of the above mentioned forecasts is the magnitude of revisions to the targets - decreases of about 50 percent of recent estimates against previous estimates. But by following results matching values by approximately the same threshold (about USD 50 per barrel), we can say that we have a clue that the major players on the financial market anticipate (and/or are betting on!) on the drawing to a close of the aggressive downward trend - at least for the next few months. And the outlook seems to be shared by companies in the field. “We believe that the decline in oil prices is nearing the end. In the second half of this year we expect oil to begin recovering from the lows reached in Q1 2015 as the global production begins to decline,” said for the Petroleum Industry Review, Goran Saravanja, chief economist of the Croatian group INA-Industrija nafte d.d. “I do not believe either in a rebound in prices to the level of Q1 2014,” he said, arguing that it takes time to adjust production, especially in an environment dominated by weak economic development.

But even if the decline ends and eventually the oil price is stabilized, it remains the main challenge for the industry for the next period. “PGNiG is closely monitoring the movements of oil prices on the market and the estimates of its development for the coming years,” said the Małgorzata Olczyk (responsible for the relationship with the press) for Petroleum Industry Review; the PGNiG specialists do not regard the phenomenon exclusively in terms of negative effects it can generate. “The drop in oil prices lead to lower acquisition prices for the assets in the field”, she added, by referring to a new direction in which the reverberations of the drop in oil prices may be transmitted in the next period, i.e. the area of mergers and acquisitions. “The financial results for nine months were not greatly affected, because the price of oil below USD 100 per barrel occurred in September, but the predictable volatility of the prices is one of the most challenging elements for us, through the influence it can have on PGNiG activities,” Olczyk underlined.


In such a context, the spring of 2015 will be a real litmus paper test for the oil and gas industry worldwide as well as for the Central and Eastern Europe. It will represent the moment to see the impact of oil price fall during Q4 last year and to see each company’s ability (the management teams’ skills as well) to counter this blow and concrete results of such measures. In fact, the spring of 2015 will draw a line between companies that can and those that can’t cope with such challenges... and, consequently, between those which deserve or those which do not deserve the investors’ money.

The way in which falling oil prices will be reflected in the financial results of companies and their management responsiveness capacity will make the difference between companies that will give the first signs of stabilization and those showing premises to re-enter a new downtrend.

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February 2015

June 2017