Oil prices in 2018 will likely be driven to some extent by the outlook for production in the US.
And according to Nikko Asset Management research analyst Stefan Hansen, headwinds to US production should remain supportive of prices in the near term.
Benchmark crude oil is currently trading near a two-year high above $US60 a barrel, following steady gains in the second half of 2017 after OPEC announced that it would extend supply cuts for a further nine months to March 2018.
Then in November, OPEC announced additional supply cuts to the end of next year as it attempts to fully drain the global supply glut that saw price fall to record lows in 2015.
However, the balancing act for global oil markets is that once prices reach a certain level, more enticing profit margins encourage US shale oil producers to ramp up production.
Within that backdrop, Hansen and his team visited multiple shale oil operations in the US to get a gauge on the production outlook.
“We’ve returned from the US relatively optimistic on oil prices leading in to 2018 given the potential constraints faced by the US onshore oil industry,” Hansen said.
Hansen noted that despite the US shale oil boom — unlocked by fracking technology — the sector has struggled to manage costs effectively which has the energy sector lag the performance of the broader S&P500.
Across the sector, Hansen said US oil producers are aiming to limit capital expenditure to around 100-105% of operating cash flow.
That’s down significantly from a peak of 162% in 2015:
“The mantra “living within cashflow” was a common statement from almost all producers, as they take heed of shareholder activism calling for a focus on returns rather than growth for growth’s sake,” Hansen said.
A recent pickup in cash-flows points to an increase of around 10% for capital expenditure in 2018.
However, many US oil producers are still aiming for yearly production growth of between 10-30% — that’s an extra 1 million barrels per day for the bigger producers.
“This strong growth in output seems contradictory to the modest growth in capital expenditure given the newly found capital discipline,” Hansen said.
“The difference between production and capital expenditure guidance appears to lie in timing, given 2018 outlooks were last set earlier in 2017, while capital discipline is more recent.”
In view of that, production outlooks may change as companies update their 2018 budgets over the coming months.
Hansen also cited signs of rising wage pressures and capacity constraints on oil-field service providers — an area which accounts for 40-60% of capital costs in shale production.
“Both producers and the service providers have all noted rising costs for pressure pumping and sand and water disposal, in the order of 30% year-on-year over 2017 so far,” Hansen said.
With service providers at capacity, the number of wells drilled but uncompleted has climbed in recent months:
The net result is that combined with the OPEC production cuts, the Nikko AM analysts are forecasting a positive backdrop for oil prices.
And while increasingly higher prices may encourage US producers to return to their high-cost ways of the past, reduced access to capital from wary investors is likely to limit sharp production increases.
Hansen and his team added the demand outlook appears strong, as global economic growth continues to gain momentum.
“Key international forecasters see demand growing by around 1.3 to 1.5 million barrels per day, and the self-imposed production cuts from OPEC and its non-OPEC partners do appear to be having an effect as OECD crude inventories decline,” Hansen said.
The team concluded that if US shale production fails to fill the supply gap and OPEC countries remain disciplined, higher oil prices may see a return to off-shore production.
However, they noted its capex-heavy nature had given oil companies little incentive to build offshore production capabilities.