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Quarter-End Insights

Energy: No Rapid Rebound for Oil Prices

The rapid decline in oil prices has created significant investment opportunities, but downside risk remains in the short term.

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  • The United States has rapidly become the critical source of incremental supply for global oil markets, and growth has come overwhelmingly from unconventional drilling. The large increases in U.S. output did not upset global supply/demand balances over the past few years, largely because significant amounts of supply were disrupted by political/security issues (Libya and Iran, for example). But in 2014 the scales finally tipped: Combined with weakening demand and OPEC's decision not to reduce its own production, major supply imbalances resulted that, as of today, have yet to dissipate.
  • In the current market environment of high costs and low oil prices, upstream firms face extremely challenged economics where new investment is not value-creative. Such conditions are not sustainable over the long term, however, and we expect the combination of rising oil prices and falling costs to provide significant relief in the coming years.
  • Despite our belief that tight oil has considerable running room from here, it can't completely meet future global demand. The marginal barrel, therefore, will come from higher up the global cost curve. Our forecasts show that higher-quality deep-water projects will be the highest-cost source of supply needed during the rest of the decade. As a result of this meaningful move down the cost curve, our midcycle oil price forecast for Brent is $75 per barrel (WTI: $69/bbl), meaningfully below 2014 highs.
  • Although U.S. gas production is likely to slow in the near term as oil-directed drilling hits the brakes, the wealth of low-cost inventory in areas like the Marcellus points to continued growth through the end of this decade and beyond. Abundant supply is holding current prices low, but in the long run we anticipate relief from incremental demand from LNG exports as well as industry. Our midcycle U.S. natural gas price estimate is $4/mcf.

Given both its remaining growth potential and ability to scale up and down activity quickly, tight oil has effectively made the United States the world's newest swing producer. Drastic spending cuts will lead to a meaningful decline in near-term production, but the strong economics of the major U.S. liquids plays means production will begin growing again as soon as oil prices recover.

Dave Meats does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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