Crude oil is a mixture of hydrocarbons that exists as a liquid in natural underground reservoirs and remains a liquid when brought to the surface.
Petroleum products are produced from the processing of crude oil and other liquids at petroleum refineries, from the extraction of liquid hydrocarbons at natural gas processing plants, and from the production of finished petroleum products at blending facilities.
Petroleum is a broad category that includes both crude oil and petroleum products. The terms oil and petroleum are sometimes used interchangeably.
Polyesters are manufactured from petroleum from which the constituent acids and alcohols are derived.
There are three steps in the synthesizing of polyester.
- Condensation Polymerization: When acid and alcohol are reacted in a vacuum at high temperatures it results in condensation polymerization. Once the polymerization has occurred the material is extruded onto a casting trough in the form of a ribbon. Once cool, the ribbon hardens and is cut into chips.
- Melt-spun Fiber: The chips are dried completely. Hopper reservoirs are then used to melt the chips. A unique feature of polyester is that it is melt-spun fiber. The chips are heated, extruded through spinnerets and cools upon hitting the air. It is then loosely wound around cylinders.
- Drawing: The fibers consequently formed are hot stretched to about five times their original length. This helps to reduce the fiber width. This fiber is now ready and would into cones as filaments. It can also be crimped and cut into staple lengths as per requirements
52 week high $107 and Low $ 42.00. Current $ 47.50
Market analysis shows that the new price levels of oil are caused by the simple mechanism of supply and demand. Globally, the 2014 slower economic growth in Europe and China took capacity planners and market makers by surprise; the developed world’s drive to decrease carbon emissions is finally having an impact on the oil market through greater energy efficiency. Demand for oil declined unexpectedly in 2014.
An end to conflict and years of reconstruction brought major oil and gas suppliers in Libya, Algeria, Iran and Iraq back to the market in 2014. The rapid expansion of tar sands supplies from Canada and shale oil in the USA squeezed suppliers such as Nigeria and Venezuela out of the US market. The world’s largest producers of oil – the USA, Russia and Saudi Arabia each had financial needs that prevented them from reducing production. Thus, there was no cut in production to match a fall in demand and the market became over supplied, causing a fall in prices.
The simplest explanation for the slump in oil prices is it falls in line with an established multi-year pattern that is being driven by supply and demand. The oil crash of 2014 was the most recent manifestation of a tidal ebb and flow in oil price volatility that has occurred every three years or so since at least the mid 2000s.
The mechanism by which a fall in the price of oil could trigger a collapse in the stock market lies in the financial devices used to fund oil exploration and exploitation throughout the world, and particularly in the United States. Modern oil exploration is financed through a range of methods including issuance of shares to increase capital, and raising debt through bonds and bank loans.
A shale oil well operating through hydraulic fracturing can cost $9 million to get into production. When oil was hovering close to $100 per barrel, banks were more than willing to finance billions of dollars worth of oil exploration projects. As far as banks were concerned these loans were backed by tangible assets and considered low-risk. It was (almost) like printing money. A price of $80 per barrel was seen as a floor in the profitability of shale oil. This took an average break-even price of $70 per barrel, plus a $10 margin for financing costs.
Today with oil under $50, many producers lose $20 for every barrel produced and will likely default on these loans, as outlined in last month’s Falling Oil Price Slows US Fracking article. This loss will be passed to the banks that made the loans, as it happened with the housing sector in 2008.
A telltale sign of this is the recent 20% fall of high yield corporate bonds since this summer which follow very closely the fall in crude oil prices. Many investors are afraid of defaults in the high-yield market due to over-lending to the energy sector and are indiscriminately selling off “junk bonds.” The downside of this corporate bond selloff across the board is that less favorable financing options will be available for other sectors, which in turn will spread the slowdown to the rest of the economy.
Simple mathematics reduces a credit-worthy company to bankruptcy – for example a company with a market capitalization of $50 million owing $9 million suddenly becomes a bad risk when its total value dives to $10 million thanks to the sudden switch from profit to loss caused by the fall in the price of oil. A loss of profitability causes a loss of share value – pension funds and investment houses have seen billions wiped off the value of their investments in a matter of a few months. The knock on effect of loss of value then permeates to the banking and insurance sectors, causing the value of stock in those companies to fall.
Not all shale oil exploitation was financed by loans and bonds. Derivatives have played a part, too and many of the main players in the fracking business have their prices set in futures contracts all the way into 2016. The holders of these obligations to buy will be in serious trouble if the oil price does not turn around by mid-2015 when many of these contracts fall due.
The major Wall Street banks hold a total of $3.9 trillion worth of commodities contract, the bulk of which are based on oil and were written when oil seemed to be destined to remain above $80 per barrel. If the price of oil stays below $80, America’s biggest financial institutions will have to beg – once again – the Fed (and the taxpayer) for help.
In addition to those companies that drill for oil and those that finance them, there is a large industrial sector supplying tools, chemicals and equipment to the oil industry and the value of shares in those companies will tank as oil production winds down. Major index component companies, such as GE and Halliburton will see a loss of business and an inability to cover investments and loans in their oil industry divisions. These financial shortfalls will affect dividend payments or force them to sell otherwise profitable divisions to cover their losses. When the value of index component companies falls, all index-linked investment funds fall into losses. Managers of these funds usually sell off profitable assets to meet their obligations. A sudden shortfall of cash caused by an unexpected fall in the oil price could then trigger a sell off on Wall Street in which case the price of all shares would drop under an urgent rush to sell.
Should energy loans start to default, we may be looking at a snowballing effect in the order of the 2008 banking crisis with a caveat: low oil prices do help reduce the cost of transportation and services and may be a blessing in disguise for the economy. However this plays out, our FFT analysis illustrates that volatility is on the cards. Fasten your seatbelts for a bumpy ride, and keep an eye open for opportunities.
As Warren Buffett once said: “Be fearful when others are greedy and greedy when others are fearful.”