How low can Sasol go?

On Monday petrochemical company Sasol saw its share price drop to R363, a price last seen in December 2012. While the price has inched up since, the shares of Royal Dutch Shell and BP are also at or near five-year lows, while Total and Exxon Mobil are trading at two-year lows.

Driving share prices down is the oil price, which has collapsed to prices last seen in the 1990s. It was in the late 90s that oil prices began to surge, reaching a high of $145.61 in July of 2008.

The brent crude price 1971 – 2016

Source: Tradingeconomics.com

The oil majors, through their entrenched positions, all earned rich profits over the period, particularly between 2011 and 2014 when the Brent oil price was stable between US$95 and US$125/barrel. Their share prices reflected this; in Sasol’s case the price gained traction reaching the R500 to R600 range.

For analysts the period of rising oil prices, from 1999 to 2008 and again from 2010 to 2014 made pricing the oil companies highly predictable, says Cobie Legrange, co-founder of Rexsolom Invest. This in turn reinforced the cycle of rising share prices.

However, the energy landscape was shaken up in 2014. Coupled with strong oil production from the US and Russia, the determining factor in November 2014, was OPEC’s decision to protect market share by maintaining and actually surpassing their output quota levels. This coupled with falling economic demand has seen the oil price fall more than 60% since July 2014.

This is forcing companies to cost-cut. All of the oil majors have reduced their head counts and cut back on exploration and new production.

Sasol started the process in 2013 with an organisational redesign that focused on simplifying the organisational structure and cutting costs out of the group – cash fixed costs from 2007 to 2012 were increasing at a compound rate of 11% annually.

By the end of the financial year (June 2016), the company expects to achieve annual cost savings of R4 billion. Overall, the project aims to conserve between R30 billion and R50 billion over a 30-month period – also ending June this year.

Over and above this, in January 2015, the group introduced a ‘Response Plan’ to ensure further cash conservation. The biggest decision in this regard was to delay the final investment decision on its gas-to-liquids facility in the United States conserving more than $600 million in front-end design spend.

It also suspended its progressive dividend policy.

What it has not cut is local production (Secunda) and the investment into growth programmes, primarily in Southern Africa (Mozambique and SA) and the US (notably the Lake Charles chemical complex). In Southern Africa a large focus is on gas, particularly the promise that gas-to-power has in Southern Africa.

However the cost-cutting, coupled with Sasol’s determination to continue to invest for the long-term, has not stemmed the fall in Sasol’s share price.

“With the Iranians bringing their oil to market the surplus of oil supply will continue for longer, pushing the price down further,” says Legrange. “Now people are suggesting that oil could reach $20 bbl, a price last seen in 2002. Prior to that, in the 80s and 90s, it was rangebound at this level.”

However Sasol is not simply an oil company. In its 2015 financial year it earned roughly half its operating profit from the Chemicals Business (made of Base Chemicals and Performance Chemicals). Oil and its derivative products are feedstocks in this business.

The rand is another factor.  At its 2015 year end results the company said that a 10c weakening in the annual average rand/US dollar exchange rate will impact profit from operations by about R650 million. This will be updated at the company’s interim results announcement on 7 March.

However, relying on the rand is precarious, and goes a little way to explaining why the share has been rangebound since December 2014.

“This animal is changing – it is no longer a solid dividend declaring momentum type stock,” says Legrange. As a result Rexsolom has sold down half of its investment in Sasol. There is no intention to sell the remainder. “Sasol is a transformative company.” In other words, it is a company that owns a ‘way of doing things’ that could change an industry or product group or services. “This process makes the company unique and viable, so no we will not sell,” he notes.

For Reuben Beelders, portfolio manager at Gryphon Investment Management, the shake-down in the Sasol share price was overdue. “I’ve never understood the attraction to Sasol. I’m not sure it’s world class and I’m concerned that management is looking at these huge ethanol crackers in an over-supplied market. I’d rather invest in BP or Shell at the right time.”

That said, he also notes that markets are exceptionally irrational and emotional. “The level of volatility in the Chinese market suggests that investors (and speculators) are very nervous.”

When might be the right time to reinvest in oil (and commodity) companies is the source of much speculation. The oil industry has a history of boom and bust and the surplus in supply will eventually fall – in line with the drop in exploration. However, the news coming out of China is not positive and the excess investment in the sector will take time to unwind, Beelders says.

In addition the more efficient consumption of oil, as well as increasing use of gas and renewable energy, is changing the face of the industry. Peak oil is a subject almost never discussed.

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