John Chatfeild-Roberts: Oil price slump is hitting profits hard

John Chatfield-Roberts Jupiter

Of the many factors that can influence global investment markets, the oil price continues to be one of the most talked about. North Sea Brent crude has recovered to the high-$60s per barrel, still 40 per cent below last June’s price of $114 before the collapse but well off the bottom seen at the beginning of January when it touched $46. However, the impact of the precipitous fall in the second half of 2014 is still very much in evidence, particularly among the oil companies themselves. Profits have been hit hard: Total, Royal Dutch Shell and BP reported significant declines in profitability arising from revenue and margin pressure on the one hand and costs being incurred on the other, as they adapt to the new conditions by shedding jobs and restructuring.

That notwithstanding, April saw the third major M&A event announced in the sector since mid-November, namely the agreed takeover of BG Group (formerly British Gas) by Royal Dutch Shell, which values BG at £46bn.

Companies are seeking to take advantage of the downturn to improve strategic positioning, as evidenced by Halliburton’s pursuit of Baker Hughes in the US oil services sector and Spain’s Repsol chasing Talisman Energy of Canada bring the aggregate value to US$111bn (£73bn) for the three transactions. We would not be surprised to see this trend continue, albeit selectively. M&A activity alongside the oil price improvement has helped underpin bombed-out oil company share prices.

Buoyant markets in China

China’s economy is still growing but appreciably slower than in the past decade. We remain sceptical of the official Chinese GDP data which shows the economy growing at 7 per cent, painting a rosier picture than other data would suggest is actually the case. The data over the past quarter suggests in our view that the actual rate of Chinese economic growth is probably nearer 4 per cent, continuing to depress global commodity prices. Against this economic deceleration, Chinese equity markets have been extraordinarily buoyant, with retail investors switching from speculating on property to buying shares (and frequently borrowing to do so). Latterly this has also spilled over to Hong Kong, where investors have been taking advantage of pricing differentials between companies’ shares listed on Hong Kong’s Hang Seng against those listed on the mainland exchanges. It remains to be seen how sustainable these heady share price levels can be but they feel unstable.

The Greek crisis grinds on

Greece’s relationship with its creditors, particularly the International Monetary Fund, deteriorated further in April as the country’s cash position became even more precarious. There is a significant risk Greece will default in the next couple of months. Our view is that Greece’s membership has defied both rational economics and the EU’s own rulebook for nearly 15 years, but it would now be a mark of considerable political failure by the EU authorities, and an admission of failure also of process and the application of its rules, to see a member summarily evicted. Even if Greece is financially delinquent, eurozone leaders are likely to do all in their power (without letting Greece off the hook) to ensure it stays in the club in order to minimise political fall-out and likely collateral damage to the currency. However, there remains a risk of a disorderly exit in which market forces rather than policy makers drive Greece out, in much the way the UK was forced from the European Exchange Rate Mechanism in September 1992.

Surprise in the UK

The recent rebound in sterling against the US dollar should, in hindsight, have been seen as a lead-indicator that, even if the pollsters were not, the currency markets were anticipating a Conservative victory in the general election. The strong bounce in the UK market suggests many investors too were wrong-footed, although clearly those who remained fully invested throughout have generally benefited thus far.

John Chatfeild-Roberts is chief investment officer at Jupiter Asset Management.