Article / 05 March 2012 at 4:51 GMT

Oil prices up - will oil company EPS rise too?

Strategist & Equity Analyst / Private

Oil prices are soaring.  Does this mean that we are going to see sector upgrades to levels seen in 2008?  It might seem counter-intuitive, but I say no, even with the Brent price approaching the highs of 2008.

Four years ago, strategists from the big investment houses got it wrong: they believed the oil price level was sustainable. Their estimates for EPS increased sharply for the years 2008-2010, see chart 1 below. Global Oil E&P EPS vs Brent Oil Price

Those estimates almost followed the oil price level in tandem, and then a dramatic decline in oil prices changed the whole picture. Earnings ended at depressing levels compared to the hyped expectations.

This time around, I think the strategists and analysts are more reluctant to incorporate higher oil prices into their EPS estimates. Instead, I suspect they will corporate the higher oil prices in an incremental fashion. As time passes, the revenue and profits are booked, and subsequently the EPS will be revised up. There is not much “forward looking” in this, but this is what I expect at the moment. A stronger for longer situation could persuade the investment banks to change their stance and a general upgrade could emerge. I see this more as a late 2012 story.

Extracting oil costs more than it used to
The above angle was a general change of momentum. Another angle to be aware of is some structural changes over the five years. Notice that increasing oil prices do not spill over to EPS over the long period seen from 2004 - see again chart 1. There are several reasons for this phenomenon. First of all the price of extracting oil has increased, as new fields are in more difficult locations, such as deep water.

This is reflected in margins. EBITDA margins have been in the 43% level in 2006-09, but in 2010 there was a drop to the 39% level and 2011E/12E are expected at the same level. This does matter a lot for the bottom line if 4% of revenue disappears to expenses on sub suppliers etc., see table 1.
Global Oil E&P Income Statement

Secondly, depreciation and amortisation has risen as increased investment is required to extract oil. This has put pressure on the EBIT margin, on top of the erosion on EBITDA level. The above factors are some of the reasons not to expect earnings to be revised up substantially on back of the latest oil price rally. EPS will not match the higher levels seen in 2008.



The Saxo Bank Group entities each provide execution-only service and access to permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on or as a result of the use of the Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer
- 沪ICP备13028953号-1

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail