“A century ago, petroleum – what we call oil – was just an obscure commodity; today it is almost as vital to human existence as water. “

James Buchan

As the quote above suggests, oil has become a prerequisite for our everyday life and one of the main drivers of the global economy. Yet despite its importance oil prices had a roller-coaster ride in 2018 as geopolitical tensions severely influenced their movement.

How Do We Determine the Price of Oil?

Since oil is a commodity, the price of crude oil is determined by traders who bid on oil futures contracts in the commodities market. That’s why oil prices change daily, depending on how trading went that day. The three main factor that influence oil prices are supply, demand and market settlement. This can be clearly demonstrated when observing the crude oil price movement at the chart below.

WTI & Brent Oil Prices

Source: Bloomberg, InterCapital Research

In the period prior to the 2008 financial crisis, rising oil demand coming from emerging market economies such as China and India coupled with production cuts by OPEC Countries in the Middle East drove the price of oil to its record heights. At the time oil barrels traded at nearly USD 150 per barrel. This changed in the aftermath of the global financial crisis as the once booming economies slowed down and were no longer in need of such large amounts of oil.

Following the recovery of the global economy, the price of oil started to regain its previous height until 2014 when the price was almost cut in half. Several factors contributed to the sharp decrease, for starters, the fast-growing economies that drove oil prices up in the past were not growing at the same rate anymore. Furthermore, oil prices came under additional pressure after Saudi Arabia refused to cut their production levels, despite the robust global output at the time. The Middle Eastern country was faced with a dilemma, either to let prices drop further or cede market share by cutting production in order to push prices up. In the end they decided to keep their production stable, concluding that low oil prices offered more of a long-term benefit than giving up market share.

Fast forward to 2018 and you are in for a treat. Oil prices have generally been on an upward trajectory for the better part of the year increasing from levels around USD 60/barrel at the end of 2017 to above USD 77/barrel in the second half of May 2018. Afterwards the price stabilized at levels close to USD 70/barrel during the summer months of 2018 and rose again in October before finally decreasing in November. In the end, both WTI and Brent oil prices recorded a negative performance in 2018 with prices down 25% and 20%, respectively. However, one should note that despite the lower ending value, the average price of both WTI and Brent was up when compared to 2017 (WTI +27%, Brent +30%). Also note that the rising prices in 2018 were primarily driven by increasing geopolitical tension regarding the announcement that the U.S. would reimpose sanctions on Iran. In turn, this led to crude prices hitting their 3 and a half year high. However, as tensions eased, and U.S. shale oil production recorded strong growth the price of oil decreased.  

Supply & Demand

Oil Supply & Demand (million barrels/day)

Source: OPEC, InterCapital Research

According to OPEC, the slowdown in global economic growth is also expected to contribute to somewhat lower oil demand requirements in 2019. Oil demand growth is anticipated to decelerate from around 1.5–1.7 mb/d in the 2018–2020 period to below 1 mb/d towards the end of the medium-term as slower economic growth, higher oil prices, efficiency improvements, the increased penetration of alternative vehicles, and lower population growth rates in the OECD and China limit growth potential.

Meanwhile, supply is expected to remain strong due to the stronger than expected growth in U.S. shale oil. Other major sources of medium-term non-OPEC supply are Brazil, Canada, and to a lesser extent, Kazakhstan, which are expected to collectively add another 2.6 mb/d by 2023.

How Do We Determine the Retail Price?

Now, if you’ve been wondering why you haven’t felt the effect of lower oil prices the last time you had to fill up your car, the answer is simple. Although regional oil companies use crude oil as an input, the lower cost of oil can’t always be transferred to the final consumer due to various taxes imposed by the Government. To present just how big of a difference do various taxes make on the final price of petrol, the chart below shows a breakdown of EUR – Super 95 and Diesel prices in EU member countries.

Source: European Commission, InterCapital Research

The Companies

There are three large downstream & upstream oil companies operating in our region which we decided to present in this market overview. They are INA, OMV Petrom and NIS. Note that we excluded Petrol as the company only operates as a retailer.

Source: InterCapital Research

In 2018, INA recorded a 22% increase YoY in operating income which amounted to EUR 3.2bn. Of that, sales revenue amounted to EUR 3bn, which represents an increase of 20%. Such an increase could be attributed to higher crude oil and product prices and increased total sales volume on domestic and B&H market.

Below the top line, INA’s EBITDA (as reported by the company) amounted to HRK 471.5bn, which is an increase of 3%. In 2018, INA’s financial income decreased by EUR 53.8m (-88%) and amounted to EUR 7.3m.  Consequently, their net financial result went from EUR 19.7m in 2017 to EUR -22.6m. To be specific, net foreign exchange loss reached EUR 5m in 2018, while in 2017 net foreign exchange gain reached EUR 30m. Further, interest payable amounted to EUR 9.2m and interest received to EUR 0.4m in 2018, while in 2017 they amounted to EUR 7.7m and EUR 0.5m, respectively. As a result, INA’s their EBT decreased by 3% (even though the company recorded an increase in EBITDA). In 2018, INA reported a net income of EUR 159m, which represents a 4% decrease.

OMV Petrom reported that their sales in 2018 have increased by 16% YoY, amounting to EUR 4.7bn. The increase in sales was driven by higher commodity prices and electricity sales volumes, which was somewhat offset by lower sales volumes of gas and petroleum products. Of the total consolidated sales, Downstream Oil represents 76%, Downstream Gas represents 22% and Upstream 2%.

Meanwhile, their 2018 EBITDA amounts to RON 1.7bn, which represents a 27% increase YoY. When looking at their EBIT, OMV Petrom observed a 59% increase YoY, amounting to EUR 1.1bn. The growth was driven by above mentioned higher commodity prices and ongoing cost optimization. Next, their Upstream benefitted from better-realized prices and lower OPEX, depreciation and exploration expenses, offsetting the impact of production decline. The Downstream Oil result reflects their strong sales performance, partly compensating the effects of the refinery turnaround in Q2/18 and the lower refining margin. Furthermore, net income amounted to EUR 849.5bm, which is an increase of 64% YoY.

In 2018 NIS recorded a top line of EUR 2.4bn, which represents a 19.7% increase. The growth came on the back of higher crude oil price, as well as the growth of natural sales (+7.4%). Below the top line EBITDA went up 13.7% to EUR 449.2m. Finally, despite the strong performance on the first two lines, net profit decreased by 6.8% to EUR 213m. The decline was due to a change in the company’s depreciation method.

For a comparison of how the market reacted to the regional companies’ results, turn to our short peer analysis below.