TEST BANK For Corporate Finance, 13th Edition By Stephen Ross, Randolph Weste...
EA-MJOrlando - NAPE Denver slides - 1610
1.
2. Valuation Assumptions
Economic Advisors, Inc., Denver 2
● our analyses must include a broad range of considerations
sector - wide (macro) project - specific (micro)
- economic considerations - technological considerations
- commercial considerations
<--------------- political considerations ---------->
3. Oil – recent history
Crude Oil Prices
US EIA, data updated September 2, 2016
Economic Advisors, Inc., Denver 3
$/bbl
4. Oil – recent history
Crude Oil Prices
US EIA, data updated February 2, 2016
Economic Advisors, Inc., Denver 4
$/bbl
China
housing
slowdown
financial
crisis
Great
Recession
fraccing
OPEC?
Russia?
Venezuela?
Brazil &
PreSal?
ISIS?
Syria?
Saudi
Arabia?
Mexico
liberalization?
Iran?
China?
5. Agenda:
Economic Advisors, Inc., Denver 5
Political risks in the market for crude oil
Commercial / economic factors driving crude oil markets
6. Oil – new conventional wisdom
Economic Advisors, Inc., Denver 6
The OPEC era is past; they’ve lost control of the market.
The US is the new swing producer.
OPEC open-taps strategy is targeting shale oil producers.
Saudi Arabia is in a battle for market share.
7. Conclusion (preview - … the short story):
Economic Advisors, Inc., Denver 7
OPEC = Saudi Arabia => dominant firm = price leader =
monopolist with competitive fringe
deceleration and diversification of energy demand (i.e. China)
technological advance in competitive fringe (i.e. fraccing)
=> increase in elasticities of D and S => [Price – Cost] markup
=> economic / commercial factors => P ≈ $60 to $80 / bbl
Political Risk per reverbations from Arab Spring (2011)
risk to control by traditional elites (political, religious)
⇒ how long can / will Saudi Arabia ‘pay’ (i.e. Poil < $60/bbl) for
advantage in emerging regional political order?
⇒ how long can Saudi Arabia afford domestic political order?
9. Is OPEC a cartel?
Economic Advisors, Inc., Denver 9
D: cartel = an association of suppliers who coordinate to
maintain high prices and restrict competition
plural
notice competing objectives here and here
10. OPEC is Saudi Arabia
Economic Advisors, Inc., Denver 10
How often do OPEC Member States exceed production quotas?
A: all the time
Who has enough spare capacity to control prices?
A:
Source: Medium-Term Oil Market Report 2014, OECD/IEA
12. Price Leader price setting
Economic Advisors, Inc., Denver 12
What has changed for Saudi Arabia (the price leader)
A: on demand side, slowdown in China
2000 to 2010 – China accounted for 40% of growth in
global demand for energy
2010 to 2015 – growth in China energy demand moderates
from 10.5%/yr to 1%/yr
2015 to 2025 – China energy demand growth est. = 2%/yr
(Source: Exxon)
2016 – China oil demand growth < 2% (though possibly
understated per ‘teapot’ refinery output, Source: Platts)
13. Price Leader price setting
Economic Advisors, Inc., Denver 13
What has changed for Saudi Arabia (the price leader)?
A: China deceleration => optimal price
What risks were present at +$100/bbl oil?
will China industrialize as a oil-intensive economy?
Will China consumer demand for energy be highly oil-
dependent? Or highly diversified?
Strategic opportunity to influence path of development?
=> optimal price
15. quantity
price
Economic Advisors, Inc., Denver 15
Price Leader price setting
S=MC
D
Q
MC
MR
Notice P-MC markup is lower with more elastic demand
P
more diversified demand
can increase elasticity
16. Price Leader price setting
Economic Advisors, Inc., Denver 16
Saudi Arabia is
price leader
dominant firm
monopolist with competitive fringe
China => P for current slowdown & to encourage oil-
intensive industrialization
Elsewhere
EM softness (x – India) => P
Developed economies softness and drop in energy intensity
=> P
17. Price Leader price setting
Economic Advisors, Inc., Denver 17
Saudi Arabia is
price leader
dominant firm
monopolist with competitive fringe
What about the supply side?
traditional competitive fringe = conventional development
(read large-fixed cost development prospects)
new competitive fringe = shale oil
18. production
($)
fixed
costs
total
costs
cost structure of traditional basins
= high ratio of fixed costs to
variable costs:
need high P to justify investment,
need low P to continue production
=> inelastic supply
Economic Advisors, Inc., Denver 18
Price Leader price setting
production
($)
fixed
costs
total
costs
cost structure of unconventional
shale oil = low ratio of fixed costs to
variable costs:
production declines rapidly, a broad
range of P will justify investment =>
more elastic supply
19. Price Leader price setting
Economic Advisors, Inc., Denver 19
Saudi Arabia = monopolist with competitive fringe
Supply Side considerations
P in reaction to more and more-elastic supply
Demand Side considerations
P in reaction to global economic weakness
P as strategy to discourage elastic mix in demand
But how low should prices be?
Shale oil drilling returns at P > $40/bbl, even if short term
Large-fixed-cost investments require confidence P > $80/bbl
for long (20+ yrs?) term
=> commercial / economic considerations => P < $80 / bbl
20. Saudi Arabia price setting
Economic Advisors, Inc., Denver 20
Economic / commercial considerations can justify prices as
low as $80/bbl (or $70/bbl? Or $60/bbl?)
But NOT P ≈ $40/bbl
Assume OPEC gain = +2MBPD, but @ $40/bbl = > +$80M/day
But monopolist incurs loss on pre-existing production
=> cost to Saudi Arabia = 10MBPD x ($40-$60/bbl) = -$200M/day
What is Saudi Arabia buying with this cost?
A: signal to large-fixed-cost projects – ‘do not invest’ (e.g. Arctic
[Shell, Russia], Canada oil sands, Brazil PreSal, Mexico)
?: but once signal has been received, what are they buying then?
22. Gulf States divide
Sunni vs Shia
Ahl al-Sunnah = ‘People of
theTradition’
632 AD – followers of Abu
Bakr, friend and father-in-law
to Prophet Muhammad
> 80% of global Muslim pop’n
> 90% in Egypt, Saudi Arabia,
Jordan, United Arab
Emirates
consideration to literal
tradition (e.g.Wahhabiism)
Economic Advisors, Inc., Denver 22
23. Gulf States divide
Sunni vs Shia
Economic Advisors, Inc., Denver 23
Shiat Ali = ‘the party of Ali’
632 AD – followers of Ali,
cousin and son-in-law to
Prophet Muhammad
~ 10% of global Muslim pop’n
significantly in Iran, Iraq,
Yemen, Lebanon
consider ayatollahs as agents
of spiritual precepts
24. Gulf States divide
Sunni vs Shia
Economic Advisors, Inc., Denver 24
Ahl al-Sunnah = ‘People of
theTradition’
632 AD – followers of Abu
Bakr, friend and father-in-law
to Prophet Muhammad
> 80% of global Muslim pop’n
> 90% in Egypt, Saudi
Arabia, Jordan, United Arab
Emirates
consideration to literal
tradition (e.g.Wahhabiism)
Shiat Ali = ‘the party of Ali’
632 AD – followers of Ali,
cousin and son-in-law to
Prophet Muhammad
~ 10% of global Muslim pop’n
significantly in Iran, Iraq,
Yemen, Lebanon
consider ayatollahs as agents
of spiritual precepts
25. Stakeholders in Market for Oil
Economic Advisors, Inc., Denver 25
domestic poli/econ interests geo-political interests
Russia (producer / price
taker)
Iran (producer / price
taker)
China (consumer / price
taker
US (consumer / price
taker)
Saudi Arabia
(producer / price setter)
how will key stakeholders influence oil markets as they
pursue domestic political/economic interests and broader
geopolitical interests?
26. Stakeholders in Market for Oil
Economic Advisors, Inc., Denver 26
domestic poli/econ interests geo-political interests
Russia (producer / price
taker)
- efficiencies of scale
- needs for hard currency
=> Supply
- influence FSU (Ukraine)
- influence in Gulf (Syrian naval base)
=> Supply
Iran (producer / price
taker)
- rebuild economy
=> Supply
- security / prosperity via Shia influence in Gulf
⇒ pro: Bashar al-Assad, Syria; Yemeni rebels
⇒ anti: Syrian rebels, ISIS
⇒ Supply
China (consumer / price
taker
- diversify to consumer-driven
economy
- improve environment
=> Demand
- Pacific region influence
=> ?Supply, ?Demand
US (consumer / price
taker)
- improve economy
- increase energy security
- improve environment
-=> ? (not touching this one)
- Gulf region stability
- Pacific region influence
- climate change
=> ?Supply
Saudi Arabia
(producer / price setter)
- maximize net returns to fund state
⇒ Price to $60 - $80 / bbl
⇒ Supply
- security / prosperity via Sunni influence in Gulf
⇒ pro: Syrian rebels, Yemeni gov’t
⇒ anti: Iranian coalitions
⇒ maintain US as consumer of Saudi crude
⇒ Price => Supply
27. quantity
price
Economic Advisors, Inc., Denver 27
Geopolitical impact on pricing
Secon&politics
D
P= $60 to $80
Q
MC
MR
P= $40
Q
Russia
Iran
US
Saudi Arabia
China
29. Looking forward - oil:
Economic Advisors, Inc., Denver 29
A: they wouldn’t.
A: they wouldn’t.
A: less critical per capital constraints.
A: Yes / No
A: the emerging priority.
A: long-term objective.
31. Outlook:
Economic Advisors, Inc., Denver 31
Oil:
OPEC will curtail production to raise prices as they confirm
Iran is a manageable risk
Large, fixed-cost investments are discouraged fr non-OPEC producers
(Canadian Oil Sands? Alaska? Brazilian PreSal? Mexico? Russia?)
* But look for Saudi Arabia to limit price increase to < $80/bbl