While prices are up over 20% in the last six sessions, they remain around 50% lower than where they were in the middle of last year. And, although rig counts have now fallen to levels not seen since 2010, according to data released on Friday, overall production globally does still remain high.
And, as Simona Gambarini – associate director for research at ETF Securities points out, while US oil rig count is pointing in the right direction, the number of active oil rigs could just as easily rise again.
Adding that the firm does not expect substantial production cuts before HY2 2015, she said, while price weakness is eventually going to hurt the profitability of US shale projects an eventuality that OPEC countries will see as a positive move, “Saudi Arabia, the largest producer in the cartel, is reluctant to give up market share and will wage the price war as long as it takes to reassert its market dominance.”
But, she added: “increasing threats from neighbouring countries might force Saudi Arabia to cut production sooner to replenish its finances.
Gambarini also makes the point that, while OPEC’s financial strength cannot last forever, the cartel may also have underestimated the resilience of US shale.
“While OPEC initiated a price war against the US on the assumption that half of all US shale output would be vulnerable below US$85, most of North Dakota’s Bakken field remains profitable at or below US$40 per barrel,” she said.
She added: “Moreover, most US producers have hedged their production for most of 2015, locking in higher prices through derivative products. While full cycle costs for shale production are around US$70 to US$80, the residual capex required to bring on an additional well is substantially lower and the price floor is decreasing by an average of US$10 a year thanks to improvements in production efficiency.”
Thus, while the game of chicken between US shale producers and Saudi Arabia continues, the time lines and the expected break points are perhaps not where the market initially thought them to be.
Implications
According to Todd Heltman and Jeff Wyll, senior energy analysts at Neuberger Berman, the lack of a Saudi “floor” on oil prices potentially means a wider trading range and shorter market cycles, for oil markets, depending on the resiliency of U.S. shale.
And, while the pair believe that there are signs of the a recovery beginning to make themselves visible, they said: “Overall, we anticipate a lower pricing band than experienced in the recent past, driven by a combination of secular and cyclical service cost declines and efficiency gains by the oil producers leading to a medium-term, mid-cycle band roughly in the $65-$85 per barrel range.”
While higher than the current price, it is a significantly lower estimate than many were expecting a few months ago.
The two add: “Overall, we believe the oil market is in the process of rebalancing, and that the result will be higher prices down the road, but it will take some time for the natural transition of production growth reduction and concurrent demand improvement to unfold. In addition, the health of the global economy remains a risk to the recovery, particularly in oil-exporting countries and parts of Europe and Asia.”
Equities
Woodford Investment Management fund manager, Stephen Lamacraft, is of the view that while lower prices are likely to be a net benefit to the global economy, there remains a question as to whether or not the lower prices are also an indication of the potential for a continued slowdown in global growth.
“Even the US will have its challenges with 40% of recent capital investment having found its way into the energy sector. Over the coming year, we are set to find out just how much of its recent economic outperformance has indeed been the result of the resource-consuming shale boom.
He added: “From a demand perspective, therefore, there are good reasons to remain cautious about the outlook for oil going forward. We have avoided the oil majors for some time. At current oil prices their cash flow doesn’t cover the dividend.
“Oil majors will either have to cut capex substantially further – as some have signalled – and by implication future growth, or cut the dividend. Neither option looks particularly good news for their shareholders.”
AXA Wealth’s Adrian Lowcock agrees adding: “As a guide investors should be looking for cover of around 1.5 to be confident the dividend is well covered in the future. Given the oil price’s sudden fall dividends in the sector could well be under pressure in 2015 especially if the oil price remains low.
This is especially relevant to income investors because the oil and gas sector accounts for around 10% of UK dividends.
Overall, it seems the only thing that is clear is that no one really has a good idea of when and how oil prices are going to move next. Medium term price predictions range from as low as $30 per barrel to as high as $200 per barrel. But, while investors may be expecting the next big move in prices to be upward, what they should keep in mind is that in the last few years, across the commodities board, each move, each phase has taken longer to unfold than the markets have expected.
