The Oil Conundrum

  Patrick Reddy, CFA
  Energy Analyst

 

In the spring of 2014, the feeling among investors was that crude oil prices would average $101 per barrel over the next year and $103 per barrel over the next 2 years. Fast forward 6 months and the global energy market is in a state of flux with oil prices having declined approximately 50% due to robust and unexpected supply growth. With the advent of new technologies such as horizontal drilling and multi-stage fracturing to extract tight oil, North America has seen a significant increase in drilling activity over the last 5 years. Specifically, oil coming from the U.S. oil shales have doubled and now represent almost 5 million barrels per day of the 9 million barrels per day of oil the U.S. produces. Outside of the U.S. oil shales, global oil production has been flat since 2006. Global oil producers were able to earn attractive full-cycle rates of returns on capital employed above $85 per barrel, but at current prices, the industry is being forced to significantly pare back drilling activity. Over the last few weeks, oil producers have signaled to the market that activity levels will fall 25% year-over-year. The decline in activity has already started to show up in new well licensing activity as well as the oil-directed rig count; a positive sign as it relates to re-balancing the supply/demand disparity. It appears the solution to low oil prices will in fact be low oil prices. In 2015, low oil prices will have a positive impact on the “consumers of oil” (i.e. the oil importing countries like the U.S., China, & India) as well as households and manufacturers.  However, looking beyond 2015 we believe prices will move higher and the “producers of oil” will prosper. So what’s an investor to do?  We believe the recent sell-off in the energy sector has presented an opportunity to buy solid companies with strong balance sheets at a significant discount to their intrinsic value. We think adding to these companies while investor fear is at its highest will lead to long-term out-performance.

 

This article is not intended to provide advice, recommendations or offers to buy or sell any product or service.  Forward looking statements are based on our assumptions, results could differ materially.

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