Oil Market Report January, 2017

Back again for another year of oil reports and as always, we will start 2017 with some predictions for the next 12 months. Before we do though, let’s consider what we predicted this time last year. Back in January (2016), the oil price was still mooching around the $30 per barrel mark and we wrote at the time that such rock bottom prices are not sustainable” and that “something has to give”. We continued that “these low oil prices will not last and a level around the $40-$50 mark, seems likely by the end of this year”. So – minor pat on the back time – that’s pretty well what happened, with the price of oil recovering back up to the high $40’s by the middle of the year. It then stayed at that level until OPEC’s now infamous meeting in November, where production cuts (in conjunction with Russia) were agreed and prices jumped up to another level, finishing the year just above $55 per barrel.

Looking ahead to 2017, the situation is less clear cut. After all, at the beginning of last year it was fairly obvious that the massive drop in prices had been overdone, smacked of trading panic and would almost certainly be short-lived. In simple terms, the only obvious direction for prices was up and so making that prediction was hardly the work of genius. But whilst the likely direction of prices in 2017 isn’t as obvious as 2016, we do still predict another year of price rises. Nothing too dramatic and perhaps nothing at great speed, but a consistent edging up prices throughout the year nonetheless, so that $65 per barrel is our guestimate for December 2017.

Based on recent history, such a prediction could be deemed reckless. With increasing oil prices, so the shale oilers will return to the market and another supply glut (and price crash) will be created. And the indicators on the ground do back this theory up, with the shalers itching to get back onto the scene when prices are attractive enough. But however keen the shalers are to get pumping again, there is no getting away from the fact that many of the operators from 2014 have gone bust, many of their wells have been mothballed and much of the available skilled labour has drifted away into other industries.

So when the shalers do come back into the game, they will be facing a different and more difficult operating environment. Firstly they will have to pay higher wages to lure skilled workers back into the sector. Then they will have to negotiate hard with the still smarting oil service firms, who will be trying to recoup as much lost revenue from the last 2 years as possible. And with less widespread drilling activity in the early days, the economies of scale around rig rental costs, drilling mud and packing sand will not exist. All of which may encourage the shale oil operators to tread cautiously over the next few months, meaning full blooded production levels are unlikely until the back end of the year.

In tandem with all of the above, we must also remember what has happened in the conventional oil industry (ie, non-shale) since 2014. Global capital expenditure has now been declining for almost three consecutive years – something that is virtually unprecedented in the modern oil industry – and this has taken place in a sector where global oil production was already depleting at an annual rate of 4m barrels per day. This drying up of conventional oil investment has clearly compounded the sickly state of non-shale exploration and an acceleration in the depletion rate to the 5m bpd mark is now predicted.

Put all of this together and you have the supporting framework for our conclusion that the next 6-12 months will bring increases in the price of oil. With OPEC cuts kicking in, conventional oil yields seizing up and the shale oil industry only making tentative movements to get back into the fast lane, there will be little downward price pressure. But if and when we do find ourselves in a $60 + price environment (and this could feasibly happen by Q4 2017), it’s at that point that things may start getting a bit more “gung-ho” – which after all is what the oil industry is famous for! And if the shalers do end up recreating the production “excesses” of 2014 – enthusiastically egged on by the Trump Administration no doubt – then a supply glut and consequent price crash would surely follow. But we will leave that prediction until this time next year…