The world's largest oil-exporting nations include members of OPEC (Organization of the Petroleum Exporting Countries), a cartel that works to coordinate members' oil policies. OPEC's actions can significantly affect the price of oil. It can withhold supply to push prices higher or increase its output to drive them lower. OPEC has wielded its power over the years, causing massive fluctuations in oil prices.
Meanwhile, oil companies that operate independently of OPEC can also have an impact on oil prices. If they allocate too much capital to new projects, they can cause an oversupply and weigh on prices. If they hold back too much, they can cause prices to surge. Since oil and gas assets are developed over a long time, companies cannot quickly increase their supplies in response to favorable market conditions.
Given the volatility of oil prices, an oil company must have three crucial characteristics to survive the industry's inevitable downturns:
- A strong financial profile with an investment-grade bond rating, significant amounts of cash on hand or ample access to affordable credit, and manageable, well-structured debt maturities.
- Low costs of operations or relatively stable cash flow streams. E&P companies need to be able to profitably sustain operations at oil prices of less than $40 a barrel, while midstream companies should get more than 85% of their cash flow from steady revenue sources such as fee-based contracts. Downstream companies should have operating costs below the industry average.
- Diversification. Oil companies should operate in more than one geographical region or be at least partially vertically integrated by engaging in several different activities.
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