Over the past two years, the oil and gas industry has seen one of the longest downturns since the 1990s. If we can take any cues from history, we can say that after every oil bust comes a recovery. However, this time the recovery is more of a slow grinding crawl, at best.
Bubble size represents market cap
FIGURE 1: PERFORMANCE OF OIL AND GAS COMPANIES
Description: Figure 1 highlights the performance of the oil and gas industry for the month of May 2017 (x-axis) and the performance of the 11 months prior to May 2017.
At the time of writing, on May 30th, WTI Crude and the international benchmark Brent Crude, both, were up 1% for the month.
Investors and executives believed that it will be years before we see oil prices return to $90 or $100 a barrel, which was pretty much the staple until the prices collapsed to ~$30 a barrel in 2014. But prices recovered to ~$50 by the end of 2016 and along with the recovery in prices came a recovery in industry sentiment that the downturn was over once and for all. Since then, prices have fluctuated a little higher and a little lower, shaking confidence in a full blown recovery.
Nonetheless, as the heavy summer driving season approaches, the political and economic upheaval in a major oil producing country such as Venezuela continues, and OPEC is expected to cut productions. Analysts believe that oil markets could be poised for another wild ride, predicting prices anywhere between $40 and $70 a barrel. Wild swings are possible, if not probable.
We still need to continue to be cautious here. With regard to OPEC, the six main member nations do not seem like they are in a position to cut. They’re broke. With their dependence on oil prices, they currently have little economic stability and they lack social stability. A common misconception among traditional analysts is that despite their desperate need for cash flow, OPEC nations will willingly agree to constrain their cash flow.
We do know that US shale production is thriving with an increase in conventional U.S. production. Trump’s choices for Secretary of Energy, Interior and EPA will ensure more conventional production.
Meanwhile, estimates for U.S. shut in capacity keep rising while the cost of drilling in shale keeps falling. Easing of energy policies across South America will lead to the production of new supplies. And cash strapped OPEC countries are being forced to borrow against future oil production. Financing before exporting is risky. If oil prices continue to slide, borrowers will need to pump more to make payments, further increasing supply and driving down prices. Under this scenario, OPEC will not be able to cut production.
To a certain extent, the Saudi’s (and OPEC) may no longer be in control of the oil prices anymore. OPEC now needs to rely on non-Opec partners if it wants to strike a balance. The Saudi’s also need to talk to their long-time enemies, the Iranians. The U.S. and Russia now hold stronger cards in the oil market, with much of the U.S. supply being used domestically at the expense of oil exports coming out of Venezuela, Mexico and Saudi Arabia.