It's hard not to get carried away by all the positive news flowing out of the Permian, given its rapid growth, multiple target zones and new pipelines providing ample long-haul takeaway for a couple of years. But just when cruising along on the Permian express was becoming a comfortable ride, a discomfiting jolt has come from an industry veteran--a wry reminder that energy is still subject to cycles.

“This time it’s different” are what Sir John Templeton termed “the four most expensive words in the English language,” recalled the senior executive of a privately held exploration and production company, speaking at the recent DUG Permian conference in Fort Worth. By his reckoning, three-plus years of oil hovering around $100 per barrel carries a meaningful risk---at some stage of the game--of a steep drop in oil price.

With this warning fresh in mind--and many industry observers vigilantly tracking the continuing buildup of inventories in PADD III to elevated levels--the views of Morgan Stanley’s Martijn Rats and Adam Longson offer a counterpoint. Rats heads up the oil and gas research team in London for Morgan Stanley, while Longson is an energy commodity strategist for the firm in New York.

The two executives’ recent commentary follows pushback by investors on the outlook for the oil and gas industry. Even if European majors could get costs under control, cut capex and improve operating performance, goes the argument, these benefits would be largely offset by a meaningful drop in crude prices. A potential drop to as low as $75 per barrel--the marginal breakeven cost cited for several project classes---is put forward by proponents of this argument.

While acknowledging the ramp-up in production coming from the U.S., Canada, Iraq and others, Rats believes “such a sharp fall in oil is quite unlikely,” and goes on to ask: “If $75 is the marginal cost of oil, why are the majors free cash flow negative at $108?”

Using 2013 data from seven major oil producers, Rats calculates a skimpy $2 per barrel margin after calculating average total costs (finding, developing, producing, taxes and other expenses) at $69.70 per barrel of oil equivalent (boe), while average revenue is put at $71.70/boe. With data split roughly evenly between gas and oil, and realized natural gas prices approaching $6 per million Btu, or about $35/boe, the average price needed to break even on the crude oil side is “$100 or slightly more.”

Rats also points to the close correlation between full-cycle costs and the average revenue per boe over the past 13 years. “To see a substantial fall in oil prices, we’d also need to see a substantial fall in costs,” he said. “We’re not seeing that. In fact, the trend over the last few years has been to rising cost levels.” As a result, “we’re starting to think about oil staying broadly flat, given the weak economics. Oil is about $108 per barrel, and already companies are slowing down capex plans.”

Longson noted that even giving credit to projected sources of supply growth--U.S., Canada, Iraq and Brazil--the supply/demand balance “doesn’t look loose.” And if the majors cut back on offshore projects that are “increasingly complicated” and “very expensive,” the balance looks “pretty tight.” On top of this is risk to production in “geopolitical hot spots”--Iraq, Iran, Libya, Nigeria, Venezuela--that also “could quickly tighten up global oil balances.”

Moreover, people tend to overlook “feedback loops that come into play” with falling oil prices, Longson said. “If we had $90 oil, we’d lose at least 10% of the global additions we expect over the next five years. $75 would be much worse. I think we could even destabilize Venezuela, producing 2.5 million barrels a day.” OPEC efforts to rebalance the market would also work against falling prices, he added.

Evidence supporting the Morgan Stanley narrative is plentiful. In late May, for example, major oil Total chose to delay a final investment decision on the Joslyn oil-sands project in Canada, pending ways to lower costs.

Certainly, cycles have not faded away. But there are always changes. Focus continues on a growing surfeit of U.S. light oil grades, making the wider export issue more pressing. However, North American markets remain linked to other world markets and the relative tightness or looseness of global balances.

Morgan Stanley is pushing back against the pessimists.

Said Longson, “It’s really hard to find a world in which we see $75 oil in the next five years.”

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