Have Oil Prices Reached An Inflection Point?
Oil prices have hit three-month highs, driven higher by the OPEC+ cuts, the U.S.-China trade de-escalation, the slowdown in shale and the apparent stabilization in the global economy.
There is a debate about how effective the additional OPEC+ cuts will turn out to be, whether the deal is significant or if it is merely a clever bit of repackaging existing realities. But the oil market bought it, helping to push prices up in the days following the announcement. The IEA still sees a stubborn glut sticking around in the short-term, but the extra 500,000 bpd in promised OPEC+ cuts helped change market sentiment.
Just days later, the Trump administration threw in the towel on the trade war, agreeing to reduce some tariffs on China and cancel others. In exchange, China has promised to buy massive volumes of agricultural goods. Again, it’s difficult to parse out reality from hype, but the fact that the trade war has shifted from escalation to de-escalation has provided a jolt to oil.
U.S. shale is also slowing. There is a wide range of production growth forecasts from analysts for 2020, with just a few hundred thousand barrels per day on the low end and around 1 mb/d or more on the upper end. But with rig counts down, drilling activity slowing and more spending cuts in the offing, it’s increasingly likely that the blistering production growth of years past is coming to an end.
Finally, a few months ago, fears of economic recession dominated headlines, but the U.S. appears to have dodged that bullet, at least for now. New data from China also shows improvement. There are still plenty of pitfalls ahead, but the global economy may have just avoided a deeper downturn.
All of these factors combine to remove some of the downside risk for oil. As a result, last week hedge funds and other money managers made the strongest shift to net-long bets on crude oil in two years, a sign that market sentiment may be turning bullish.
“We are beginning to see early signs of generalist re-engagement in Energy discussions,” Goldman Sachs said in a note, which is jargon for the renewed interest from investors in energy stocks. “Investors are beginning to take note of improved performance of higher-beta sub-sectors like Oil Services and E&Ps, but there is a debate if this is the seemingly annual transitory optimism or if a combination of producer discipline, OPEC cuts and a potential US-China trade detente means a bottom has been established.”
But one of the bigger questions is whether U.S. shale will bounce back. Goldman said that investors are more confident now than they were in the past that shale would not rebound in response to slightly higher prices. In other words, major money managers think that the OPEC+ cuts may have the desired effect, pushing up prices in 2020.
Others are not so sure. “In the medium term, this will doubtless give a renewed boost to exploration activity in the US…and will make even higher US production next year more probable,” Commerzbank wrote in a note on Monday. “Thus the rise in the oil price already carries within it the seed of its upcoming decline, and the yo-yo effect on the oil market is likely to continue.”
Shale’s struggles work in the favor of those betting on higher oil prices. A new report from IHS Markit finds that the base decline rate for Permian drillers continues to grow, meaning that it takes more and more effort just to keep production flat. “Now that capital markets have closed for many companies and investors are requiring returns, a critical objective for these companies is to slow production growth, significantly moderating their base declines,” Raoul LeBlanc, vice president of Unconventional Oil and Gas at IHS Markit, said in a statement.
IHS says that U.S. shale will only grow by 440,000 bpd in 2020, before flattening out entirely in 2021. It’s safe to say that the market is not using this as their baseline, so if IHS turns out to be right, there could be a substantial rise in oil prices.