Analysts Differ On Outlook For Oil Markets

By: Pat Roche

Article originally published by the Daily Oil Bulletin on Jan 13, 2016. It can be accessed here: http://www.dailyoilbulletin.com/article/2016/1/13/analysts-differ-outlook-oil-markets/  

The global oil glut will shrink in the second half of this year and supply will match demand in 2017, a top analyst expects.

World crude production currently exceeds demand by about 1.5 million bbls a day, and that oversupply will continue during the first half of this year, but will drop significantly in the second half, predicts Mike Wittner, head of oil market research at Paris-based investment bank Société Générale S.A.

“So the important thing is the second half is going to look and feel much different than the first half of the year,” Wittner told a Conference Board of Canada oil and gas conference in Calgary on Tuesday.

He said statistics about oil inventories in Organization for Economic Co-operation and Development (OECD), which are more reliable than non-OECD data, tend to drive prices.

In the second quarter of this year, a lower OECD stock build will be “the light at the end of the tunnel for a more balanced market in 2017,” Wittner predicted. “So just to be clear: this is not going to be a balancing year; it’s next year. But by the second half of this year we think we’re going to get a taste of that.”

U.S. shale decline to accelerate

Wittner expects the decline in oil production from the three big U.S. shale plays to gather momentum in the latter half of 2016.

In the wake of the oil price slide, which began in mid-2014, production from the Bakken, the Eagle Ford and the Permian has been more resilient than many expected.

Total U.S. oil output peaked last April at 9.7 million bbls a day. By October, the most recent month for which figures are available, U.S. production had fallen by only about 350,000 bbls a day — which won’t have much impact on a 96-million-bbl-a-day global market.

“It’s still the U.S. that the market is looking at to get the rebalancing process underway,” said Wittner, who views the weak shale production response as “a big reason” for continuing low prices. Also, he said declines from the shales have been offset by new projects ramping up in the U.S. Gulf of Mexico. Unlike shale wells, multibillion-dollar offshore projects take years to bring onstream and aren’t typically shut in when prices collapse.

But while output from shale plays can fall with prices, Wittner noted it can also rise as prices recover.

The Société Générale analyst said one reason production declines from the shales have been so gradual — even as the rig count fell precipitously — is that roughly 80 per cent of the output comes from roughly 20 per cent of the wells. So a 40 per cent cut in capital spending idled rigs in the poor areas rather than the sweet spots. This was also one of the factors cited by IHS Energy which did an in-depth analysis of what’s happening in the shale plays (DOB, Dec. 14, 2015).

While Bakken and Eagle Ford oil production is declining, the Permian has been bucking the trend, but Wittner said preliminary data from the U.S. Energy Information Administration indicates Permian production is starting to flatten out. He believes this foreshadows an acceleration in the total decline from the U.S. shale plays.

“That’s kind of what our forecast is based on for a steepening pace of decline this year,” he said. He expects the increasing difficulty of raising money through debt and equity will also affect production.

“[Last fall’s] round of borrowing base re-determinations was, by and large, pretty gentle on the E&P companies,” Wittner said. “The borrowing base was only trimmed by about 10 per cent. That’s expected to take a much bigger hit this spring.”

He said the biggest factor governing the production outlook is capital spending, which was cut by 40 per cent last year and which Société Générale expect to be cut this year by another 25 to 30 per cent — or more.

“Unless prices bounce back in the next couple of weeks, we expect announcements to start coming out that spending is being trimmed even further,” Wittner said.

Société Générale expects West Texas Intermediate (WTI) crude to average roughly US$40 a bbl this year, or roughly $35, $40, $45 and $50 a bbl in the first, second, third and fourth quarters.

But Wittner added a caveat: “One key factor for the markets — both for the fundamentals and for the market psychology — continues to be U.S. shale. If U.S. shale does not decline the way we think, we’re going to be at a much lower price.”

“But really, the current price environment strengthens my confidence that U.S. output has to go down,” he added.

Eventual return to US$75 a bbl?

Whether prices will ultimately return to US$75 a bbl will depend on whether global demand growth can be met without high-cost production, Wittner believes.

Demand is expected to continue to grow at a “reasonably healthy” 1.2 million bbls a day this year, he said, after growing by a “much healthier than expected” 1.8 million bbls a day last year.

Wittner puts the supply options in three cost categories.

“You have low-cost Middle East crude. You have medium-cost U.S. shale oil. And then you have high-cost production from the Canadian oilsands [and] deepwater offshore.... If you believe that we can meet demand growth from low-cost Middle East crude oil and medium-cost U.S. shale oil, then we’re not going to [$75 a bbl]. We don’t need to. All we need to do is go back to [$50 or $60 a bbl]. Fine,” he said.

“However, when you work the numbers, I strongly believe that we cannot meet global demand growth from low-cost and medium-cost crude. If we can’t do it with Middle East [crude] and U.S. shale oil, we’re going to need output increases [from projects in the] Canadian oilsands and deepwater offshore. If that’s the case, prices, one way or another, have to go back to $75 in order to make that happen.”

Sub-$30 threshold looms

For Ed Morse, head of commodities at Citi Research, Wittner’s presentation apparently wasn’t quite bearish enough.

“One point that Mike didn’t mention in his commentary: we’re now confronting $20 oil, not $40 oil,” Morse told the conference.

Speaking to reporters later, Morse said: “It’s hard to be optimistic over the short term when you have as much inventory being put into storage as we’ve seen happening right now [and] when Iran is going to put a significant amount of oil on the market.”

He added: “I think a lot of the uncertainty about Iran will dissipate once we know how much oil they’re actually [going to be] putting in the market. It may take a month or two months.... Whatever the number is, whether it’s 100,000 barrels a day or 500,000 barrels a day of incremental supply. This will have a disruptive impact on flows because it will take market share away from somebody somewhere and that oil will have to find another home.”

Pressed for his own outlook, Morse suggested $20 WTI shouldn’t surprise anyone. Given that WTI has been hovering just above $30 a bbl, “the likelihood is fairly great” that it would fall below $30 a bbl, he said. (Later on Tuesday, WTI did briefly dip below $30 a bbl.)

Asked about the view of some analysts that prices will improve in the second half of this year, he said there is no consensus, adding that it is “always dangerous” to predict when prices will hit bottom. “Reading Bloomberg this morning, I saw one analyst who is perpetually bullish who is now looking at a $10 level of prices before you hit a bottom.”

Morse suggested a good sign that prices have hit bottom will be major consolidation in the industry, which Citi expects to occur in the second and third quarters of this year. “By that time maybe we’ll have a good judgment call that the bottom will have been passed.”

Low prices unsustainable

But even Morse doesn’t believe oil markets can sustain low prices.

“They cannot maintain a price below the $30 level for very long. The question is: How much longer?” he said. “We, like other market analysts, have prices going up — not much in the first half of the year, but in the second half of the year after we see more industry consolidation, after we see some more supply coming out of the market. The adjustment up could be fairly dramatic.”

Morse expects the shut-in of stripper wells — wells that produce 15 bbls a day or less — could significantly reduce U.S. production.

“The U.S. has more than a million barrels a day, maybe as much as 1.5 million at its peak in 2015, of oil coming from stripper wells,” he said. 

About half of that amount -- or roughly 750,000 bbls a day at peak -- was from wells producing a bbl a day or less, he said. "They have cash costs in the $50 to $60-a-barrel range. That's a big chunk of oil -- 700,00-barrels-a-day-plus -- that's not profitable... You can expect that to disappear. That's a big chunk of oil to come out of the market."

2016 to average $40 a bbl?

Glen Hodgson, senior vice-president and the chief economist at the Conference Board of Canada, believes it may be 2017 before oil gets back to $50 a bbl.

The not-for-profit research group, which organized the conference, prepares forecasts four times a year. It last ran its model just before Christmas.

“At that point we felt we were being very prudent making an assumption [for] this year of $40-a-barrel WTI oil,” Hodgson told the audience. “And that may well prove to be a prudent assumption.”

Noting that while “we’re all freaking out with oil at [roughly] $30 today,” he observed “a year’s a long time.” But he fears that a return to “even something around $60 a barrel is going to take a number of years.”