Thina Saltvedt, Nordea Bank’s chief analyst for oil, reveals why oil prices rise and fall, and why shipping companies are so good at managing this risk.

Words: Alannah Eames

AFTER TEN YEARS of high oil prices, most of us got a shock when they began to slide from an average of USD 112 per barrel in 2012 to USD 60 in May 2015. “It’s a very complex and unpredictable, but fascinating industry”, says Thina Saltvedt from Nordea Bank, who has been analysing the oil sector since 2006. “Oil prices are very influenced by politics and can vary dramatically from one minute to the next.”

So, why do oil prices vary so much? According to Saltvedt, it’s because it’s such a secretive industry. “It’s a small market and a lot of information is kept secret,” she explains. “It’s often difficult to know how much oil China or Saudi Arabia really has or can produce. It’s this speculation and uncertainty that makes oil prices fluctuate.”

OIL PRICES HAVE been dropping for the past two years for three main reasons. First of all, the US has been pushing its huge supply of shale oil on the US market. A decade of rising oil prices has triggered the shale oil boom in the US, and Russia has been producing oil at record since the breakup of the Soviet Union. Secondly, there has been an unexpected slowdown in global demand for oil, with the exception of India and China where demand is increasing. Thirdly, OPEC – the Organization of the Petroleum Exporting Countries – changed its strategy in 2014. OPEC was formerly a cartel that controlled its members’ oil production and dominated world oil prices. Now, it is trying to increase its market share by flooding the market with cheap oil.

“THE SHIFT TO GREEN ENERGY IS GOING MUCH FASTER THAN EXPECTED”

Saltvedt believes the OPEC change will have the greatest impact on oil prices. “Historically, when the oil price dropped below USD 100 per barrel, OPEC used to cut production to raise the price or they used extra capacity to steer the market in the way they wanted,” she explains. “Now, I think oil will get cheaper because the cartel is ramping up production to push prices down and squeeze high-cost producers rather than cutting production to support prices. But this new approach will hit the more expensive oil producing countries like Russia, Canada and Norway,” she warns.

THE OIL INDUSTRY is going through one of its most challenging periods. Not only are oil prices dropping, but there is increasing competition from alternative fuel sources like gas and ‘greener’ renewable energy. The shift to green energy is going much faster than expected, according to Saltvedt, but it will still take time to build up the necessary infrastructure and vehicle fleet. She praises the shipping industry for introducing new and innovative solutions to protect itself against fluctuating oil prices and to meet tighter environmental regulations.

“Shipowners don’t have time to sit and speculate on oil prices. They want to focus on their core business, which is shipping,” she says. “Because they spend so much money on fuel, they are very good at managing their fuel risks – hedging, developing new cleaner engines, or using dual-fuel ships. They are better prepared than others to deal with changes in oil prices.”

PREDICTING FUTURE OIL prices is a bit like trying to win the lottery. But Saltvedt believes the oil prices will be under pressure in 2015, rising slightly to USD 75 in 2016, and will stay “relatively low” until 2017. “By then we will see the effect of today’s lower oil prices and we might see prices increasing again. But it’s hard to say because it is a long cycle between the time the oil is developed and when it enters the market. Anything can happen.”

Her advice to combat oil price fluctuations: “Estimate how much oil you use and calculate how sensitive your cash flow is to oil price fluctuations. Since the financial crisis, we have all learned to prepare for unpredictable outcomes. Then, develop a fuel risk management or hedging programme to minimise your exposure to oil price changes. But also follow the dollar currency exchange rate as this is often tied to oil prices.”

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Jan Eyvin Wang

Jan Eyvin Wang, president and CEO, WW ASA.

Reducing fuel consumption is top priority for WWASA

WILH. WILHELMSEN ASA – which owns the ships in the WW group – spends around half a billion USD per year on bunker fuel; its vessels use around 800 million tonnes of oil per year. Most of the bunker fuel is purchased in Singapore and Rotterdam. If oil prices go up by 40–60% operational cost increases as the fuel cost makes up 40–50% of the total voyage expenses.

That’s why WWASA takes measures to reduce fuel consumption wherever possible. “WWASA does this by optimising its vessel operations, introducing new vessel designs and new technology as well as monitoring and optimising performance, weather routing, slow steaming and awareness training on-board,” says Jan Eyvin Wang, president and CEO of WWASA. “There are also bunker cost clauses in customer contracts which allow us to share some of the risk with our customers. These were introduced several years ago when the oil prices started to rise rapidly.”

WWASA also uses hedging to avoid being affected by highs and lows in oil prices. Hedging means signing contracts with oil suppliers for future supply of fuel at a fixed price so the company knows what price it will pay for its fuel for the next three to five years, for example.