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Saturday, 4 April 2009

I bought Singapore Petroleum Company on 27th March 2009

Rationale

Ever since the crude oil prices hit around US$ 30 sometime ago (from a record high of above US$ 140 last year), I believe the business fundamentals for oil companies (e.g. SPC) have made a U-turn.

There are a two main sources pressuring their income statement:
  1. Inventory write down (declining oil prices)
  2. Declining revenue (from falling demand and refining margin)
Given the speed at which crude oil prices had collapse by Dec 2008 (around US$ 40), the inventory write down should more or less been completed by the last FY report, ending 31st December 2008.

While demand will take some time to recover, the downside will be limited given current widespread dependence on crude oil for basic subsistence.

I could have bought it earlier, when SPC share price languish slightly above $2, but spare cash is a rare commodity nowadays and it is only recently that I am able to scrape enough to buy some.

Potential for more inventory write down

Oil prices trends

The following is the crude oil future contract compiled from Energy Information Association:


For a relatively long time in modern history ( 1986 to 1999), the world seems contented with crude oil around US$ 20. Assuming an inflation rate of around 3% to account for rising living standards (greater convenience in life centred around electricity use and motor transport) and adding another 1% for world population growth, the resultant stabilised oil price is still about US$ 30 (9 years from 1999).

Cutting supply to boost prices?

The following chart is also compiled from Energy Information Association:

Despite a few relatively small crisis, Asian financial crisis in 1997/98 and SARS in 2002/03 (compared to the present) from 1997 to present, there was no notable cut in supply even though prices took a sharp dip (see oil futures chart above) in both periods. In fact, supply continue to grow steadily over the years. Cutting supply to boost income doesn't really make sense unless the surge in price is sufficient to offset the (promised) plunge in volume. Since the volume normally does not drop as much as promised, the price is not boosted as expected. On the contrary, if demand continue to drop, the oil producers instead have to increase production to sustain their income, more so in a bearish oil market.

Taken together, the potential inventory write down in coming quarters is still material but not as significant as when the crude oil price was above US$ 100 per barrel.

Declining revenue

The following charts is the refining margin published by BP, annual average and weekly average respectively:


Given current volatility in crude prices, margins are volatile as well. But generally, on a broader scale, as crude price stablise and demand falls back to earth, a margin of around US$ 2 to 3 should not be too much to ask for. When refining margins were that low (2002, 2003), SPC's downstream activities could still deliver about SGD 30 to 50m operating profit (or about 1.5% operating profit margin).


Upstream activities

Perhaps, the only cushion to the declining revenue (and profit) from the downstream activities is from the exploration and production (E & P) activities. However, with a sharp drop in crude prices, the contribution from E & P will also drop drastically compared to 2008 but still higher than the downstream activities.

Risk

The only risk I can see (other than oil price collapsing to zero and people stay indoors to burn candles) is the hedging activities carried out to hedge against oil price exposure. Despite stating that the SPC adopted a prudent risk management policy, unexpected high volatility in oil prices can render such activities useless and even implicit damage to the income statement.

Conclusion

Not too long ago, when oil price was aiming for the moon as it surge to US $147 per barrel, all sorts of infrastructure investment was launched to increase production. Now, as the price crashed back to earth, many investment was scrapped (also due to the ongoing credit crisis) as the projects are not justifiable at current crude prices. Thus setting the ground for future supply crunch again. Anyway, as fundamentals reach or about to reach a turning point, its about time I collect some for the future.

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18 Comments:

Blogger BL Trading Team said...

Do you know that crude oil is raw material for SPC? Many have bought SPC because they think oil price will rise, that is a wrong understanding of the business model.

9 April 2009 at 14:36  
Blogger Market Uncle said...

Yap,
Basically, like other firms like SHELL, BP, they generally have 2 businesses, upstream (oil & gas production and supply -- high margin) and downstream (refine crude and deliver processed products -- low margin)

Upstream activity is dependent on crude prices while downstream is dependent on stable, not rising or declining, crude prices. And both are dependent on demand.

Thus the 3 set of graphs I compile to conclude fundamentals have more or less bottomed.

9 April 2009 at 20:30  
Blogger Black Cat said...

I'm investigating SPC for another reason. On the charts, from November to April, it is one of the few (less than 30) SGX stocks in a clear uptrend, while most others made new lows in March.

Not sure yet whether I'll look at it as an investment or speculation, but this blog entry is an excellent starting point.

Thanks,
BlackCat

11 April 2009 at 00:38  
Blogger BL Trading Team said...

If you believe that oil price will rise, why don't you just buy oil ETF?

14 April 2009 at 10:10  
Blogger Market Uncle said...

Hi Blackcat,
Thanks for dropping by. I'm a non-believer of technical analysis and believe it is just a consequence or reflection on underlying change in either fundamentals (long term) or market & emotional stochastic (short term).

I buy SPC only because I think there its fundamentals have or going to change for the better.

14 April 2009 at 21:16  
Blogger Market Uncle said...

Hi BL Trading Team,
So far I'm only interested in STI ETF and invest in it using CPF just to beat CPF interest rate.

As for oil ETF, there's no such ETF trading on SGX that I know of. The closest I can find is LYXOR commodity ETF, where oil futures is but one component. Please correct me on this.

Anyway, yes, I do believe demand for oil products will ultimately pick up (but not necessary oil prices) and hence I'm more keen on SPC (Too bad I can't invest on other oil companies).

Once the demand picked up, the volume of crude and processed products & services will picked up, translating into more revenue for these companies. Depending on how the oil producing countries react initially, oil prices might not move much yet if the escalating surge in produced volume multiplied by the languishing (temp) prices results in lucrative income.

For the same reason, we know demand of raw materials will ultimately pick up and their prices will surge, but that does not mean we all just invest in commodity ETF. There is so much more value various companies can add to these raw materials to churn out profitable products and services to be even a much better investment.

14 April 2009 at 21:26  
Anonymous Anonymous said...

Hello Market Uncle!

Good posting on SPC! I'm also starting to take note of this business.

I've been passionately doing a bit of value investing for a while now and since Feb 2009, I've built a site around this theme and would like to exchange links with like-minded individuals like yourself.

If you like my suggestion, do let me know if you're comfortable having me to link to your site at:

http://www.ValueInvestingAtSg.com/value-investing-blogs/

while you link my main site from your blogroll?


Thanks.
Be Blessed & Good Investing!

14 April 2009 at 23:05  
Blogger BL Trading Team said...

The problem with most Singaporean investors is that they only look at SGX.

Oil ETF is traded in US, stock code is OIL.

In US, there is also agriculture ETF, short index ETFs, currency ETFs etc.

15 April 2009 at 10:01  
Blogger Market Uncle said...

Hi Wai Loong,
Sure, I don't mind exchanging links. Thanks.

15 April 2009 at 21:13  
Blogger Market Uncle said...

Hi BL Trading Team,
I'm just speaking for myself, as a Singaporean, I invest for a peace of mind. By investing outside SGX, my holdings will no longer be rest assured on CDP but some other 3rd party trust account. If anything happen to that 3rd party, there is almost no discourse for me. Please correct me on this.

2nd, by investing on foreign platforms, e.g. US, I'll be exposed to unnecessary forex risk. If I want forex exposure, I can choose to buy equities quoted in USD, AUD listed on SGX. If I want to prevent forex volatility of SGD vs other currencies, I can choose to horde gold.

In short, I'm happy with just investing in whatever I can find on SGX since I'm still early in my investment phase where capital appreciation is my main objective.

Towards the mature phase where capital appreciation is balanced with capital protection, I'll diversify out into other currency quoted equities or even really beyond SGX. It really depends how much I had then.

In my twilight years, most probably I'll just moved everything to dividend yield play (REITS, bonds, t-bills etc) to survive on passive income.

15 April 2009 at 21:22  
Anonymous Anonymous said...

Hello Market Uncle!

I've linked your blog onto my site together with some other Value Investing link partners at:

http://www.ValueInvestingAtSg.com/value-investing-blogs/

You are most welcome to link me on your blog-roll at your own convenience.


Be Blessed & Good Investing!

16 April 2009 at 22:54  
Anonymous Anonymous said...

one analyst in Today predicted target of $1.80 for SPC when it was at $2.02. It has more than doubled now. again I was stupid enough to listen to all this crap in Today paper from stockbroking houses.

23 May 2009 at 15:51  
Blogger Market Uncle said...

Hi,
The recent run up of SPC does not tie in with fundamental improvements. If the market is factoring eventual earnings recovery from improving demands, this forward looking buy up might be taking things too far. Unless there is unpublished favourable events, I do not think the this price is sustainable in the short run.

24 May 2009 at 11:42  
Anonymous Anonymous said...

Hi MarketUncle,

Great call to buy SPC at around 3, you have doubled your money in 3 months, are you selling it to petroChina?

Regards

V

27 May 2009 at 17:15  
Blogger Market Uncle said...

Hi,
Nope, not selling unless I'm forced to.

28 May 2009 at 22:00  
Anonymous Anonymous said...

Hi MarketUncle,

Thanks.

Just wanted to check with you on your take on it.

I was very happy when you bought this.

My take is that it will reach 15 odd by the time it is 2013.

Cheers

V

1 June 2009 at 09:39  
Blogger Market Uncle said...

Hi,
Without petrolChina coming into the picture, I'd assume this is a long term investment and won't sell before the boom when oil demand shoot through the roof to create the next bubble. Price wise, I can't give a number.

But now that PetrolChina comes into picture, it really depends how many shareholders will surrender their shares. Hopefully, it doesn't becomes private so that it can realise my hope above.

1 June 2009 at 20:59  
Anonymous Penny Stock Newsletter said...

I still believe in the idea of buying stocks involved in nuclear energy even after the very serious nuclear problems in japan after the earth quake. this is still the most viable alternative to coal oil or anything else it is also the cheapest form of energy that you can use to produce electricity. you can now buy stocks in the nuclear energy business at a discount.

12 December 2011 at 14:16  

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