How high for the oil recovery is always an important question given its implications for inflation. At the moment, the oil market has returned to its usual bullishness with all sorts of analysts forecasting a new supercycle:
For me, this is deja vu all over again. There is no doubt that the oil market has tightened with inventories falling in the US:
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The question is why? Demand has recovered through 2020 but it is still very poor. The main reason is that OPEC is holding some 8mb/d off the market.
And shale oil production fell 2mb/d as well:
But, at $60 WTI we are now well above shale break evens. We need to ask if the rebound will come. It has already started in shale:
RBC reckons the rebound will be slow:
First Look at 2021 Budgets
Most US E&P budgets coming with earnings over the coming couple of weeks. Our expectations are that 2021 spending levels stay flat YoY, following last year’s 50% drop. Despite a more robust oil price outlook, most management teams have committed to spending discipline with few deviations.
Early report card “A” given a more subdued outlook. Overall, budgets (compared to expectations) are 2% lower for upstream activity and 15-20% lower for midstream. This reinforces our view that US oil production shows only modest growth through most of 2021.
Messaging on disciplined spending remains a clear theme. Running the businesses for FCF generation and returns continues to be the main focus, and although recent oil strength is appreciated, management teams remain disciplined. Based on our/consensus forecasts, we expect the 50 US E&P companies we track will spend 1% more in 2021 to $40 billion, which is also down 50% from 2019 levels.
In Canada, most companies have budgets that show an 8% YoY increase to $11 billion, which is down 32% from 2019. International E&Ps are up nearly 25% YoY due to a few special situations. Caveat, Biden administration policies could cause some budget shifts and possibly elevate spending in 2021/2022. If the Administration pursues more draconian actions and not renew or issue permits on valid federal leases, that could result in companies adding activity to work through permits before they expire (see our note on federal land exposure by operator).
Higher hurdles for midstream spending might be here to stay. Midstream companies that prioritized capital project scrutiny and rationalization (thereby placing more emphasis on FCF generation) have fared best through earnings. In the current environment investors largely view midstream as overbuilt and prefer maintaining current payouts and reducing aggregate debt, leverage, and ideally stock buybacks. We believe this framework can find a home in the Biden administration’s accelerated “energy evolution” with midstream operators already working to position some assets to participate.
But I hear this at the beginning of every new cycle. A more likely outcome is that when oil breaches whatever greed point that breaks OPEC discipline ($70-80?) it will be closely be followed by shalers and the market share battle will recommence. The oil market is just too fragmented for sustainable price control.
So, like other commodities, this looks much more like a classic cyclical recovery to me than it does some kind of “supercycle”. When OPEC opens the spiggots, China begins to slow and US growth runs away reversing the USD falls, oil will fall away as well.
I’d guess we peak before year-end and next year should be another $60/b price.
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