U.S. shale producers have cut their capital spending, but their output hasn’t fallen correspondingly.
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Oil prices have spiked 30% this year, rebounding above pre-pandemic levels even though fuel demand is still well below normal. Air travel is severely depressed as vaccines continue to be rolled out, and auto traffic hasn’t fully rebounded everywhere.
But projections for demand have been improving, while producers in the U.S. and elsewhere have been bringing back supply much more slowly than analysts had initially anticipated. In addition, commodities have come back into favor as some investors prepare for inflation.
All that has made oil one of the best trades of 2021.
Some analysts have been boosting their targets for oil prices well beyond prior levels and preparing for a long bullish period for oil. A so-called supercycle would entail higher-than-expected demand and prices for several years, giving a big boost to producers.
But Citi analyst Ed Morse, who has been bullish on oil, expects the price gains to moderate. He has a strong record of predicting oil’s moves, forecasting the 2014-2016 plunge and keeping on top of other swings since then. He correctly predicted last month that oil would get to $70 faster than others were anticipating. It did so on Monday.
Now, he is starting to tap the brakes. While many analysts viewed as extremely bullish last week’s decision by OPEC and its allies to very gradually bring back production taken off line in response to the pandemic, Morse thinks it could backfire. Once OPEC brings back supply, he thinks oil will trade between $40 and $55 a barrel, writing that “$70, let alone $100+, looks highly unlikely.”
On Tuesday, Brent crude futures were down 0.5% to $67.88 per barrel and West Texas Intermediate futures were down 1% to $64.43.
Although U.S. shale producers have cut their capital-expense budgets considerably, their production has not fallen off as much because their operations have become much more efficient. Outside of the U.S. and OPEC, there are also considerable amounts of production capacity that is profitable to operate even when oil is below $50. That means that when oil is above those levels, producers have an incentivize to add more supply, thus dampening prices.
Those lower break-evens are “a big part of why we see oil prices mostly in the $40-55 range,” Morse wrote. “Sustained prices much above this range can bring on significant project volumes, loosening the market. Prices much below this range could lead to very tight markets.”
And OPEC’s capacity is likely to grow considerably in the next decade, with members like the United Arab Emirates, LIbya, and Iraq adding a cumulative 5 million barrels a day of potential production by 2030. Others outside of OPEC, such as Brazil, may also be able to increase production. Brazil could potentially boost its capacity to 4 million barrels per day from 3 million.
OPEC and its allies may be able to move prices higher in the short term by curtailing production.
“However, should OPEC+ overtighten markets to support oil prices above $55-60 or higher, this looks to set up major periods of looseness that could cause large sustained price sell-offs,” Morse wrote. “OPEC+ will need to recognize this dynamic. They can manage market volatility on a monthly basis, but medium-term stability would be at risk should they move too far from the $40-55 range.”
Write to Avi Salzman at [email protected]
