Crude Oil, Gas Outlook: The New Bullish

A report from DrillingInfo released April 16, “Redefining Bullish,” updates the firm’s five-year outlook for commodity prices, supply and demand. The analysts are putting forward a more cautious forecast for the oil and gas sector.

“We’re expecting a recovery, but not as large as initially anticipated at the end of 2016,” Maria T. Sanchez, manager of energy analysis, told Hart Energy.

“In our report for fourth-quarter 2016, we forecast $4.25 [per Mcf] for natural gas and $52 [per bbl] for crude,” she said. “Our gas forecast for 2017 is now $3.50, and although our crude forecast hasn’t changed, it doesn’t look as solid. Now, to stabilize at $52, we need the OPEC cuts extended and demand growth. For gas, the mild winter slowed the recovery. Overall, the recovery won’t be as dramatic.”

Some positive support for crude at $52/bbl or higher was evident at press time, as a report from the U.S. Energy Information Administration (EIA) was expected to confirm bullish American Petroleum Institute inventory data released on April 18 “that indicated a 6.6 MMbbl net draw of crude and key products,” said a note from Tudor, Pickering, Holt & Co. “A reminder that crude was $48/bbl a short two weeks ago. … Crude is now +$5/bbl, inventories are starting to confirm a fundamentally tight market, and the contango in the futures market is eroding.”

The DrillingInfo report noted that for crude prices to average between $50/bbl and $52/bbl in 2017, OPEC must “extend quotas through year-end 2017 and maintain reasonable compliance, demand must grow at least 1.34 MMbbl/d, and Libya and other countries must keep production growth to a minimum. Only when these criteria are met can the high crude oil inventory levels be normalized to levels from prior to the price crash by year-end 2017.”

Is it likely that these requirements will be met? Sanchez said she thinks 1.4 MMbbl/d in global demand growth is reasonable and can happen.

As for OPEC, “We do believe the OPEC cuts will be extended because the first cuts didn’t balance the market. If not, prices won’t remain at this level. The only reason they proposed cuts was to allow prices to recover from lows. If they don’t extend the cuts, they lose their purpose.”

Saudi Arabia won’t cut further, and Libya may grow production, particularly as it has export terminals in the works, but perhaps not enough to depress crude prices. Sanchez pointed out that with E&Ps continuing to expand U.S. production as they become more efficient and produce at a lower cost, “they aren’t helping to balance the market.”

Natural gas demand may not be sufficient to prop up prices, and DrillingInfo forecasts $3.50/Mcf in 2018 and just $3.25/Mcf in 2019. “We’re expecting an increase in gas prices over this year because production levels are really low, 2 Bcf/day below 2016 numbers, and demand is higher by 2 Bcf to 3 Bcf/day.”

“Prices need to rise to incentivize producers,” Sanchez added. “A lot of good production growth will happen from the Northeast as additional takeaway comes on, but producers still need stronger prices.”

The report’s analysis of U.S. oil play breakevens (those that achieve a 20% after-tax minimum acceptable rate of return at $3.50 Henry Hub gas and WTI less than $60) found plenty of them are in the money below $60/bbl, with many economic at $50/bbl or below. Sanchez said that E&Ps’ earnings calls detail continued success in pushing costs lower, albeit not as steeply as in the past. “We keep hearing it on the calls,” Sanchez said. “There’s always something that shows improvement from previous quarters.”

In terms of capex budgets, E&Ps and their investors are adjusting to new, lower rates of return in many cases, Sanchez said. “The business can still be economic, but the margins are just not as big as before the downturn. It’s the new normal.”

Investors are becoming more comfortable with the E&P sector, and capex is coming back. But earnings calls also indicate that capital has more strings attached than in the boom days. “Companies are expected to manage more how the capex will be invested. We hear companies saying that depending on what prices look like, they might push some drilling to the next quarter,” Sanchez said.