From the Securities Lending Trading Desk: Mid-Year Viewpoint on Oil and Gas

When we last reported on the oil and gas sector, supply was increasing as a result of robust production across the globe, while overall demand was weak.  These factors contributed to volatility in the market and spurred securities lending demand across related sectors.

In this article, we highlight the latest trends in the sector and discuss how these developments are manifesting themselves in the securities lending market.  

When we last reported on the oil and gas sector in April, U.S. oil futures were roughly $46.00 a barrel -­their lowest levels since April 2009. At the same time, securities lending fees were at historic highs and many stocks within the sector had fallen to 52-week lows. Today, oil future prices have risen nearly 30% — trading at approximately $60.00 a barrel on the New York Mercantile Exchange. Fee levels for stocks in the sector have eased, while shares prices remain depressed.

In its weekly Petroleum Status report, the U.S. Energy Information Administration (EIA) reported a decrease in crude oil inventories of 1.9 million barrels for the week ending May 29, versus expectations of a draw of 1.7 million. Despite this decrease, U.S. crude inventories remain near levels not seen for this time of year in 80 years and, as a result, stock values remain low.

OPEC held their scheduled meeting in Vienna on June 5, where members agreed to maintain their collective output of 30 MMbpd (million barrels per day) for the next six months. Over the past year, crude oil production by OPEC’s member nations has outpaced this goal, adding more supply than intended to the market. The market consensus is that oversupply will continue to put pressure on crude oil prices.

Outlook for the Securities Lending Market

Barring the unlikely event of any major changes in production and oil rig count, we expect fee levels to remain lower than they were in the first half of the year, but continue to generate significant income for lenders. We do not anticipate a substantial rally in stock prices across the sector. Supply is expected to continue to far exceed existing demand, which in turn, should subdue the possibility of new demand.

Until stock prices begin to rally and hold some sort of gains, there is not much of an entry point for bearish investors in the market. This isn’t entirely negative news for lenders, as we anticipate that the oil and gas sector will remain in focus as long-term investors in the sector maintain their positions amid sector volatility and uncertainty.

We also anticipate an increase in merger and acquisition activity across the oil sector during the second half of 2015, as smaller companies with weaker balance sheets look to survive the recent price collapse. Oil-related M&A activity was at an all-time low in the first quarter of 2015, however analysts are suggesting that a number of independent companies might be coming off their hedging positions and would need to raise capital if oil prices remain steady. Most recently we are seeing evidence of this with the announcement of Energy Transfer Equity’s proposed merger with The Williams Cos. Though the deal was rejected, we suspect this is just the beginning for M&A in the sector.

An increase in M&A deals with stock components would be a benefit to lenders and position this as the front­runner for securities lending story of the year.

Quick Facts

  • During the first half of 2015, U.S. oil futures have risen roughly 30%, while stock prices and lending fees in the oil and related sectors remain low.
  • Reports from the Organization of the Petroleum Exporting Countries (OPEC) and U.S. Energy Information Administration (EIA) show that both inventories and supply remain high, which may continue to put pressure on crude oil prices.
  • M&A activity, volatility, and uncertainty over future prices will keep the sector in focus into the third quarter; however securities lending fees are expected to remain lower than the highs seen in early-2015.