By Julie Hammond, CFA
The supply/demand equation for global oil markets is in the middle of a major supply-side reset that should provide support for oil prices going forward, according to Jennifer Stevenson, a portfolio manager with 1832 Asset Management L.P. (a subsidiary of Scotiabank).
Source: Getty Images/Ascent Xmedia
There are opportunities for North American oil and gas companies, even if a "border adjustment tax" is passed in the United States or the North American Free Trade Agreement (NAFTA) is renegotiated, Stevenson explained to the audience at the CFA Institute Latin America Investment Conference. Her research found that global demand for oil will continue on its upward trajectory, fueled by growth in emerging markets.
Stevenson said that the excess supply and inventories that contributed to the collapse in oil prices from 2014 to 2016 are now coming down substantially. Looking forward, these reductions will provide price support.
Supply Reduction on the Production Side
Stevenson segmented supply-side sources of oil production into three buckets: OPEC, North America and the "Rest of the World" (ROW), and described how each contributes to energy market dynamics.
In the ROW countries, production fell primarily due to the extreme drop in oil prices, which reduced cash flows and access to capital for maintaining production levels. An extra 5 million barrels per day (bpd) of production that was scheduled to come online in 2019-20 was eliminated by the cancellation of $1 trillion in international projects, which means that the additional production effect will be felt in the future.
In November 2016, OPEC signed an agreement to cut 1.2 million bpd of production, which took effect in January 2017. "As of the end of January 2017, they were 83% in compliance with the plan, which is spectacular," Stevenson said. The agreement was designed to increase oil prices and enhance the economies of participating countries, and Stevenson attributed its adoption to Saudi Arabia's deputy crown prince Mohammed bin Salman, who is also driving the "Saudi Vision 2030" plan designed to reduce the kingdom's dependency on oil.
Saudi Arabia has strong incentive to maintain high oil prices. About 85% of the country's GDP is tied to oil. In October 2016, Saudi Arabia raised $17.5 billion in the largest-ever bond sale from an emerging market country. In 2018, Saudi Arabia is expected to raise $1 trillion in an IPO for a portion of the country's national oil company Saudi Aramco (Private:ARMCO). The country may tap bond markets again, and higher oil prices mean a greater valuation for the IPO and a more secure bond rating.
U.S. Energy Self-Sufficiency?
Although the Donald Trump administration is pushing for US energy independence, that's easier said than done. The United States imports 7.6 million bpd, and of that amount, 3 million bpd come from Canada. The remaining 4.6 million bpd come from Mexico and other countries. Adding production means a commitment of capital for labor, equipment and infrastructure, which would require staying power and, needless to say, higher oil prices.
"The U.S. Republican party left out a word out in their policy platform to achieve America's 'energy independence from foreign suppliers,'" Stevenson said. "That word is 'North.'" She observed that "it is possible for the North American energy independence equation to work, if Canada and Mexico supply all of the gap in US production."
Supply Reduction: Global Inventories
Stevenson sees global inventory draws as another sign that supply and demand are rebalancing in the right direction. "We are starting to draw down inventories globally, but nobody knows about it," she said. The media and markets are largely fixated on U.S. inventories, which are reported twice a week.
"We are headed toward the lowest level ever for OECD inventories," Stevenson said, "and this is very supportive of prices." Saudi Arabia, which is fully aware of the visibility of U.S. inventories and the importance of location, can assist in further U.S. inventory reduction by reducing supplies to the United States.
Technology Driving the Sector's Improved Efficiency and Profitability
Stevenson explained that fracking and other technological advances, developed mainly in the United States, have increased the efficiency of capital and raised profit margins, despite wells costing more. "Margins today are as good as when the price per barrel was $30 higher," she said.
These advances in technology will eventually be applied in other global reservoirs, particularly in areas like Argentina, which Stevenson says has a "fantastic reservoir" in the Vaca Muerta. Overall, Stevenson sees the sector adding jobs, but at a lower rate than in the past.
Benefits to North American Oil Companies
Stevenson was positive on the energy sector and expected demand growth to continue. She said that the short cycle production to feed this demand growth will most likely come from North America.
And the outlook for oil prices? "OPEC has given us a $50 floor," Stevenson said. Near-term, she predicted that we will see $60 per barrel as the ceiling at which more projects will come in, although there will still be constraints on labor, equipment and infrastructure.
"In the oil industry today, $60 per barrel is better than $50, and $70 is life changing," Stevenson said. She is bullish on supply growth in North America over the longer term. "We've canceled $1 trillion worth of energy spending globally in the past two years, and OPEC cuts speed up the recovery," she noted.
The supply rebalancing could mean prosperity for North American oil companies.
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