I think it’s no understatement to say that most energy analysts are fairly cautious at the moment. Last week analysts at French Bank Societe Generale nicely summed up the consensus view thus: “ With preliminary end-June stock data for Europe released yesterday, SG estimates that combined US, OECD Europe, and Japan crude and product stocks drew by 14.9 Mb, or around 500 kb/d, with almost all of the decline in crude. Based on the US stats, the trend has continued into early July. However, the market is still not convinced that this matters, and may be waiting to see the US oil rig count start to falter, or see signs that OPEC may be considering steeper cuts. So far, neither has happened. Moreover, if it takes another two or three weeks of stockdraws for the market to sit up and take notice, that will bring us into August, when the market will be just as likely to conclude that the summer is almost over. Global crude runs peak this month, with a decline of 1.2 Mb/d expected between July and September, as planned maintenance starts to kick in. The bottom line is that we are cautious.”
As I’ve said many times before the key driver is now unconventional oil and gas – shale – in the US. OPEC might have pretentious about being the marginal supplier of choice, but the North American’s are the real price setters.
In this respect, a note from the energy team at Guinness caught my eye. It’s a fairly balanced analysis of the confluence of the shale operators:
- “The US onshore system continues to get more efficient, particularly in the Permian basin. Oil recovered ‘per lateral foot of well’ has continued to increase and the signs are that it will increase again in 2017 and probably 2018. This is partly driven by structural improvements and partly as a result of high grading (drilling the best wells first) and is dominated by the new high activity levels in the Permian basin (which has the most prolific resources).
- Drilling and completion activity has ramped sharply and there are now infrastructure, sand and labour shortages which are causing cost inflation. Cost inflation will eat into the economics of the E&P companies and their ability to deliver growth at lower oil prices.
- The capital markets remain open for E&P activity. There have been limited signs of distress in the high yield debt markets and E&P companies are back to outspending their cash flows in the pursuit of production growth.
- We note recent comments from Pioneer Resources CEO Scott Sheffield indicating that his company can drill wells at $25/bl oil prices. Pioneer has the best of the best acreage in the Permian and while his company will clearly continue its activity at lower oil prices, we do not believe that this representative of the overall US system.
- The ability for the US system to deliver growth will get tougher. At the moment, the base decline of total US oil production is low (as a result of the 18 month drilling hiatus) therefore new wells can deliver absolute production growth rather than just offsetting underlying decline. As production builds up, the underlying decline rate will increase and more wells will be required to deliver a required amount of absolute production growth”.
Guinness concludes thus: “ for all the ‘success’ of US shale in its return to growth at current oil prices, there are virtually no producing companies generating a return that is above cost of capital, even in the prolific Permian basin. This gives us optimism that economic logic will eventually prevail in oil market, as it has done in previous cycles, leading to an oil price that does allow an economic return for participants. We see this closer to the long-run marginal cost of supply ($60-70/bl).”
I’m not completely convinced this is the case. My suspicion is that there’s an awful lot of reserves out there economic at $40 to $45 a barrel – in the US and beyond. And it’s these reserves that will continue to set the price, driving innovation and pushing expensive marginal producers out of the market.
On a broader note, I’m also increasingly concerned that investors will begin to worry about the real value of long term reserves in a low carbon world. My sense is that the divestment movement is gaining momentum and more and more investor’s will be inclined to add an even bigger discount to any NPV for oil assets. This will have an impact on everything from corporate bond pricing through to sovereign debt analysis.