Should analysts reset their U.S. Gulf outlook?

On July 3, the crude oil futures price finished the day at $46.77 a barrel, the eighth consecutive daily increase, a record extending back to 2009. The price rise was a welcomed respite after crude oil had fallen by more than 20% before rallying.

This isn’t where oil prices were supposed to be after OPEC and its non-OPEC supporters agreed in late 2016 to cut their combined production by 1.8 million barrels per day, or about 2% of global supply. The failure of this cut to produce a meaningful reduction in global oil inventories has forced the OPEC/non-OPEC producers to extend the cuts for another nine months, or through the end of the first quarter of 2018.

The oil price performance so far this year, despite the latest price increases, has forced forecasters to cut their price projections for 2017 and 2018. In some cases, the cuts have been by double-digits. For the first half of 2017, oil prices fell by 14.3%, topped by a 17.6% fall in natural gas prices. The weak performance for commodity prices impacted the performance of energy stocks as the S&P 500 energy sector fell 13.8%.

With the worst first half oil price decline since 1999, the question is: Do we need a reset for the Gulf of Mexico?

The key is whether the low oil price becomes the benchmark against which offshore oil explorers peg their spending. A newspaper headline suggested that oilfield activity would suffer as the fall in oil prices wipes out the well break-even reductions of E&P companies. What the headline may be missing is the record oil hedging by producers earlier this year when prices were substantially higher than now. That means producers will enjoy higher cash flows than suggested by current oil prices. It begs the question of whether current oil prices will prevail for the next 18 months.

A third of all oil price forecasters, responding to a new CNBC survey, said they still expect oil prices to end 2017 in the $50-$59 bbl. range, but 47% think the price will only be in the $40s. As important as near-term oil prices are for offshore operators, the real issue is how they see that price three to 10 years in the future, when new fields drilled now come into production.

There are several truths about the future of the oil business. For the foreseeable future, crude oil will be needed to power the global economy and improve mankind’s living standards. Second, the law of physics for reservoirs — depletion — will force the oil industry to seek new supplies to offset lower output. Third, despite the success in exploiting shale formations, the offshore remains the world’s most prospective region for new large oilfields. Those forces will drive E&P companies to seek ways to develop new offshore fields at lower break-even prices allowing offshore activity to grow.

No one has suggested that the offshore activity recovery will come soon, but current low oil prices won’t change the timing, materially.

About the author

G. Allen Brooks

G. Allen Brooks is a 40-year veteran of the energy and investment industries, serving as an energy securities analyst, an oilfield service company manager, a consultant to energy company managements and a board member of several oilfield service companies. He is the author of the highly regarded energy newsletter “Musings From the Oil Patch” that interprets trends within all sectors of the energy business.

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