A Bullish Outlook For Oil Investors

Summary

  • While crude prices have been volatile in recent months, data continues to support the view that the market is firming up.
  • Right now, investors are acting very pessimistic, when in fact the picture suggests things should improve further later this year.
  • Add to this unexpected events that may or may not (but are likely to) transpire, and this could be the start of something really bullish.
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Even though crude prices have been falling recently, with investors racked by fears regarding global growth and rising US output, new data coming out suggests that any real degree of pessimism is misplaced. Thanks to a new report, courtesy of the EIA (Energy Information Administration), it is looking a lot more like this year will result in a global oil deficit and, next year, while leaning toward a surplus, will not be so bad as to warrant a downturn in prices. If anything, when all of the data is taken together, it looks more and more like investors in this space should be bullish, not bearish, because in any scenario where the global economy does not weaken, crude prices should likely rise from here as inventory levels, at worst, stay nearly flat, and at best, decline some moving forward.

A look at production

In the table below, you can see some production and consumption data I collected from the EIA's Short-Term Energy Outlook. The current forecasted data for each category covers the most recent info available, while the prior forecasted data covers what the EIA reported a month ago. What you can see by looking at this is that, if its estimates are correct, global oil production will continue rising this year and next, but the amount of output globally on a daily basis will be lower than anticipated in April.

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For instance, global supply this year should come out to around 101.11 million barrels per day, up 0.44 million barrels per day compared to 2018, but down 0.41 million barrels per day from the 101.52 million barrels per day previously forecasted. In short, for this year, the amount of oil production growth forecasted has been cut by nearly half in just one month's time. This will carry over into next year, it seems, with output then being 0.18 million barrels per day lower than previously estimated. In all, the three-year period the table covers implies a reduction in output globally to the tune of 211.88 million barrels.

Unfortunately for this year, demand, as the table illustrates, will also be lower than forecasted, but only by 0.02 million barrels per day. Next year, however, we should see this more than made up for, with demand expected to average 102.89 million barrels per day. As a result of these supply and demand differences, it's actually implied that instead of seeing a surplus in production this year of 0.14 million barrels per day, we should see a deficit globally of 0.25 million barrels per day, a swing of 0.39 million barrels per day. Next year, it is still planned for there to be excess production, but that has been slashed from 0.38 million barrels per day down to 0.14 million barrels per day.

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Even as the picture looks better there from a rebalancing perspective, oil production in the US is set to soar. As you can see in the table above, oil output in the US should average 12.45 million barrels per day this year, up 1.49 million barrels per day compared to 2018 and higher by 0.06 million barrels per day compared to the EIA's prior forecast. Next year, output should rise even more, averaging 13.38 million barrels per day, up 0.93 million barrels per day compared to this year and 0.28 million barrels per day above last month's forecast. This is how things should have been for years, with OPEC and other producers making way for rising shale.

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In the next table above, meanwhile, you can see that not all will be well within OPEC. Production there this year is forecasted to average 30.29 million barrels per day, down 0.24 million barrels per day compared to the prior forecast and quite a bit below 2018's 31.96 million barrels per day. Next year, output from the group should fall even further. To investors who don't believe this will come to pass, April data from OPEC points to output averaging 30.45 million barrels per day in the first quarter of this year, with output in March alone having fallen to 30.02 million barrels per day. Even if Saudi Arabia and Iraq (the two nations most capable of raising output materially) manage to increase production, continued losses from Venezuela, as well as sanctions-related losses in Iran, and periodic geopolitical losses associated with Libya and Nigeria are very likely to result in output continuing to decline through at least next year (unless the other OPEC members change course and decide to abandon their production cut plans).

A look at inventories

As a result of changes in the EIA's forecasts, we can get an interesting look at what inventories in the US and among the OECD as a whole should look like near-term. As you can see in the table below, US commercial crude and product inventories by the end of this year should total 1.301 billion barrels, 11 million barrels lower than previously forecasted. Next year, this should rise some to 1.322 billion barrels, but that's still lower than prior forecasts.

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The bigger change comes from the OECD as a whole. As the table illustrates, inventories this year should only climb by 10 million barrels and will be 45 million barrels lower than forecasted last month, while they will be lower next year by 80 million barrels compared to prior expectations. Pairing this data up with OECD demand, even as stocks should rise, we arrive at OECD inventories totaling just north of 60 days' worth of consumption at the end of next year, signaling a glut of just 10.6 million barrels by then. This does not, however, mean that prices don't go higher from here.

You see, according to the OPEC+ production cuts, Russia is supposed to decrease output from 11.40 million barrels per day last year to around 11.19 million barrels per day this year. Instead, the EIA has this figure rising to 11.54 million barrels per day this year, followed by an increase to 11.77 million barrels per day in 2020. Even though Russia has not fully complied with production cuts, it has cut some, so anything shy of it reaching these EIA-estimated limits will result in OECD stocks likely coming in even lower this year and next.

Takeaway

Based on the data provided, it seems pretty clear to me that the oil picture is rapidly improving. Even though prices have retreated recently, data is aiming toward an ever-tighter market, and I suspect that if demand remains robust and if OPEC and its non-OPEC peers adhere to their current arrangement for the remainder of 2019, it's only a matter of time before crude prices trace higher again. As this occurs, as I believe it will, it should help most, if not all, of the oil and gas companies in this space as well.

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This article was written by

Daniel Jones profile picture
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Robust cash flow analyses of oil and gas companies

Daniel is currently the manager of Avaring Capital Advisors, LLC, a registered investment advisor that oversees one hedge fund, and he runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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