Think About This
INVESTMENT RESEARCH
So , in the short run the tightness in the market is obvious and could even get worse as the weather gets colder and refinery runs rise . But what about the medium and long term ? Much of the trade in oil takes place beyond this year , in the futures market . Longer term prices of oil suggest that supply and demand will return to balance , with prices trending back to marginal cost . But if investment in supply remains subdued these markets could be very wide of the mark . If they are , super normal returns across the industry could persist which would suggest many share prices in the sector may be very cheap indeed .
To answer the question about the direction of longer-term pricing we need a view on the supply beyond the next 12 months .
First let ’ s look at the industry whose remarkable genesis has flipped the US from being a net importer of oil to an exporter : onshore US shale oil . As it currently stands US oil companies have all but halted new drilling , prioritizing shareholder returns and paying down debt . Having been burned by the oil price collapse in 2014-2016 and then again in 2020 , investors are holding companies to their promise of capital discipline . Dividends and buy-backs are better rewarded than spending to increase production even after the recent surge in oil prices .
WTI CRUDE OIL FUTURES CURVE
85 80 75 70 65 60 55
12 / 21 |
04 / 22 |
08 / 22 |
12 / 22 |
04 / 23 |
08 / 23 |
12 / 23 |
04 / 24 |
08 / 24 |
12 / 24 |
04 / 25 |
08 / 25 |
12 / 25 |
04 / 26 |
08 / 26 |
12 / 26 |
04 / 27 |
08 / 27 |
12 / 27 |
04 / 28 |
08 / 28 |
12 / 28 |
04 / 29 |
08 / 29 |
12 / 29 |
04 / 30 |
08 / 30 |
12 / 30 |
04 / 31 |
08 / 31 |
12 / 31 |
Sources : Bloomberg , Deltec
This is why the recovery in drilling activity is modest , too modest even to sustain production at current levels . Shale oil wells decline at a very fast rate and therefore require constant drilling to replenish lost supply . We think the rotary rig count needs to be between 800-900 to lift production . The current count is 556 .
Besides , although US production has risen fractionally this year , the small increase in production we have seen comes from utilizing existing Drilled but Uncomplete Wells ( DUCs ), analogous to drawing down on inventories .
www . deltecbank . com Deltec Bank & Trust Limited