Nothing lasts forever including low oil prices. The price of crude oil has been at historically low prices for several years now and for some investors these prices are looked at as the new norm. But volitility is everywhere in the markets and some experts predict a major shift is coming soon.
“Perfect storm” is a terrible way to start a title. It sounds cliche, unoriginal, and attention grabbing, but that’s exactly what we believe will happen – the perfect storm is coming.
The foundation for why we believe oil prices will rise higher are based on the following theories:
- Overconfidence in the U.S. shale industry, which leads to capital expenditures being diverted from supplies that would have guaranteed more stable long-term supplies to short-cycle supplies;
- Lack of capital investments in global oil supplies, resulting in faster decline rates;
- Years of low oil prices fueled demand spikes that will be inelastic to oil price rises in the future;
- The fall in the U.S. dollar is a natural boost to global demand; and
- High storage leading to complacency on geopolitical risks boiling in the Middle East.
The fifth item above is just a matter of time. With relatively low global supply disruptions in the oil markets today, it can almost be forgotten that there are conflicts in the Middle East, but that’s exactly what we are seeing. The premise for oil prices to move higher is not contingent on war, nor does it require there to be war. But a close study of the geopolitical landscape of the Middle East causes us to arrive at a different conclusion.
In this article, you will see a step-by-step walk-through of how we are envisioning the world’s response, and how the U.S. shale landscape will play out.
U.S. Shale: The Shine Is Fading
Central to the “lower for longer” thesis is the ability for U.S. shale producers to push the global oil markets back into oversupply the moment oil prices rise. The consensus represented by big Wall Street banks says that at $60/bbl or $70/bbl, U.S. shale can grow – and not just a few 100k b/d either, but 1 million b/d year over year. As the story goes, if demand grows at 1.2 million b/d, that doesn’t leave much room for other producers to grow. As such, oil prices will remain range-bound.
On paper, this theory sounds attractive. “Lower for longer” – it allows the strongest shale producers to raise external capital, which then translates into fat investment banking fees. It’s a win-win, right? Wall Street banks get paid their underwriting fees, and U.S. shale producers get to drill.
Not so fast. Does U.S. shale have the potential to throw the world back into oversupply?
The shine on the U.S. shale industry began to change at the start of 2017. Even as oil prices remained resilient, U.S. shale producers saw their equity prices decline by more than a quarter. External financing essentially ground to a halt, with a dismal $6 billion raised this year. Why would you raise equity when your stock price has halved, right?
Then came the EIA 914 monthly surveyed production reports. People started to ask questions, like “where’s the shale growth?”
Some supporters of the “lower for longer” thesis will say, “Well, oil prices dropped, so that’s why production disappointed.” But those who have used that excuse as a reason are disregarding the fact that for the first six months of 2017, WTI averaged $50/bbl – smack in the middle of where the “shale band” is supposed to be.
There’s a saying that bad things happen in threes. Well, EIA’s latest STEO said that U.S. crude production should be 9.24 million b/d in July and 9.2 million b/d in August. That’s greatly understating where the weekly productions are, and puts U.S. oil production as essentially flat for the last eight months – a fact that will soon be impossible to refute by the “lower for longer” crowd.
The third bad thing to happen to the U.S. shale story will be the dismal well performances in Eagle Ford. We wrote in our flagship report, “Shattering The Consensus View On U.S. Shale,” that the premise that Eagle Ford production will grow rapidly will prove to be where the “lower for longer” crowd downfall stems from.When thinking about the U.S. shale industry, there’s one important insight to remember: In order to grow, you need to drill and complete more wells than you did before. Unlike conventional production, where the decline rate is low and one location can be upgraded to produce more oil, U.S. shale is like an assembly line. More and more wells need to get completed and drilled every year just to grow, and that’s where the logical issue lies.
For the Eagle Ford to complete and drill more wells, it will compete against the Permian for workers. Think about it for a second: Why would service crews go to Eagle Ford when the Permian pays more? How does Eagle Ford then attract the attention needed to get the workers to come? It’s all about the Benjamins, and that will inherently push the shale “breakeven” higher.
On Friday, we read an interesting report by Rystad Energy. The report noted that the EIA’s recent downward revision for U.S. oil production was in line with its original estimate. We checked their May oil market report and saw that that was flat-out false.
Filed under: Commodities