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Oil & Gas Industry Outlook - July 2017

Date:07 21, 2017 Author:Nilanjan Choudhury

Crude Oil

Last year, 'Energy' was the strongest S&P sector performer, with a market-thumping 24% return. In particular, November's historic OPEC-led production cut deal to alleviate a supply glut managed to buoy oil prices and stabilize them around the psychologically important $50 per barrel threshold. The commodity was on a stellar run on optimism surrounding the agreement, and the outlook for oil stocks was getting better.

The seemingly positive developments encouraged investors to bet on firming prices for 2017 with the oil industry finally hoping that 'this would be the year.' True to the strong sentiments, U.S. oil prices reached around $55 per barrel in late February, the highest level in 19 months.

However, the situation is drastically different now, with the commodity having floundered in recent weeks. By June 21, crude had cratered more than 20% from its February highs and officially plunged into bear territory. In fact, prices ended down 14.3% for the first half of the year – the worst performance since 1998. Therefore, it was not surprising that ExxonMobil Corp. (XOM) and Chevron Corp. (CVX) – the DJIA’s two energy giants –  were among the 7 Dow stocks that closed the first half with a loss. Both scrips experienced sharp declines in price this year, dropping more than 10% year to date when the index (with a rise of 8%) marked its best first-half performance since 2013.

Apparently, there was one small thing that the bullish speculators didn’t account for – the spectacular boom in U.S. shale production. Arguably, the biggest development in global oil markets over the last few years, the relentless increase in North American shale output has undermined efforts by OPEC and other major producers’ efforts to ‘rebalance’ the market and prop up prices.

Supply Side Woes Plague Oil Market

Apart from the much-discussed shale production issue, there are some other reasons why oil markets remain oversupplied.

At the crux of the matter is the rising flood of U.S. shale-driven production. Now at a financial equilibrium, the shale firms are putting more rigs and employees back to work. Throughout the downturn, producers worked tirelessly to cut costs down to a bare minimum and look for innovative ways to churn out more oil from rock. And they managed to do just that by improving drilling techniques.

With these efforts, many upstream companies have repositioned themselves to adapt to the new $50 oil reality and even thrive at those prices. In other words, while OPEC's moves to trim output and rebalance the demand-supply situation have stabilized the market to a large extent, in the process it has incentivized shale drillers to churn out more. As per EIA's latest inventory release, crude production over the last 4 weeks averaged about 9.31 million barrels per day, up 7.2% from the same 4-week period last year.

The extension of supply curbs by top producers led by OPEC also disappointed markets. At a meeting in Vienna in May, the cartel (plus non-members led by Russia) decided to roll over their output cuts of 1.8 million barrels per day (bpd) to reduce global oil inventories until Mar 2018. The move, though widely expected, spooked some oil market investors who hoped that the cuts would be deepened/lengthened further.

Meanwhile, the producer cartel pumped more oil last month than in May – the second successive monthly rise in 2017 – on increasing output from Nigeria and Libya, which are exempt from the deal. The production boost offset improved compliance by other members.

OPEC Fails to Curb Oil Glut

It’s quite clearly evident that the output-cap agreement spearheaded by OPEC has failed to achieve its stated goal of bringing global crude stockpiles down to five-year averages. Even the various energy-monitoring bodies – EIA, IEA, and OPEC – have of late projected that U.S. crude production will continue to ramp up through 2018, thereby leading to slower-than-expected market rebalancing.

To sum it up, oil’s future direction will depend on the battle between the OPEC-led output cuts and the increase in U.S. shale production. But as of now, it seems that the ‘lower for longer’ oil is there to stay well into next year.

Rebound in the Cards?

Some analysts believe that oil prices have bottomed out following the recent selloff. While a significant rebound is out of question due to the lingering supply-demand imbalance, one could expect some short-term price gains.

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