A Crude Attempt to Understand Marginal Barrels Coming Out of the US

Kalim Aziz
March 30, 2015
  • The market is flooded with research notes downgrading the oil price week after week
  • Data from Bakken Shale suggest year on year flat production break-even for the US shale is US$ 65-70 per barrel
  • We believe the oil price will recover to around US$ 68 to keep shale production flat and self-fund the E&P segment within the next 12-18 months

Oil price has been downgraded by 26%

We have seen a plethora of research notes from the broker community as well as commentary from a variety of media pundits in the last 3 months.

What is consistent from the published notes is a clear and systematic downward revision of oil price forecasts week after week. In between November 2014 and February, oil price forecast for the year 2016 has been downgraded by 26%. In February, however, the 12 month forward (WTI) recovered some of the losses rising 21% from its low to US$ 67.5.

Chart 1.: WTI Crude Oil (12-month Forward))

Source: Bloomberg, Helgi Analytics

Almost all commentators believe that the oil price will remain under extreme pressure during the 1H15 and may recover somewhat in the 2H15. According to the latest market consensus, the oil price should touch the bottom low of US$52 per barrel in February/March, and gradually rising to US$ 66.4 in 2016 and US$ 69.6 in 2017 (all figures for Brent).

Chart 2.: What Market Thinks About the Price?

Source: Bloomberg, Helgi Analytics, US$ per bbl

Based on the January's World Bank's Outlook, average oil price (a mixture of Brent, WTI and Dubai) should be growing 6.7% p.a. until 2025 breaking the US$ 100 per barrel in 2025 only.

Intriguing is the forecasts moves by the analyst community in as much that even the ‘recovered’ crude forecasts are significantly below the ‘cut’ estimate from a couple of months ago. Current forecasts by market pundits (Morgan Stanley, Goldman Sachs, JP Morgan etc.) run between mid-to-lat US$40/barrel to low US$50/barrel for 2015 and range between mid-US$50s to low US$60/barrel in 2016

A comparison with 2008/09, or 1985/86?

There is a lot of commentary around the current drop in oil price is unlike 2008-9 but more similar to 1985/86, and, economics of shale oil production in the US is so much more improved that they can sustain a lot lower oil price and by implication, the recovery is likely to be more U-shaped than V-shaped.

Conclusion

We fail to understand how the community could cut the break-even oil price for marginal oil from US$85-95/barrel to US$45-65/barrel in less than half a year!

Our guess is that Newtonian behaviour (a body in motion continue to remain in motion….) where price of crude is the lead indicator of marginal cost forecasts and/or cut in price crude price forecasts.

Oil price average of US$68/barrel is a level at which marginal barrel supply is not taken out of the market supply.

Kalim Aziz
Kalim Aziz
Senior Analyst at Duet Asset Management LLP, London
Mr. Kalim Aziz spent more than 20 years analysing companies in the global emerging markets. Kalim served as a Head of EMEA Research managing over 30 analysts at ING Groep in London and later headed Equity Research of the EMEA Region at UniCredit Banca Mobiliare in London together with Centralny Dom Maklerski Pekao in Warsaw and Koc Yatirim in Turkey, altogether covering more than 100 companies in the region. In 2006, he moved to the buyside as a Co-fund Manager of Kairos Eurasian Fund with Guido Brera. Kalim now helps managing equity fund at Duet Asset Management in London. Besides, he owns a consultuancy company Kiradvisory Limited, an affiliate of Helgi Library on various analytical work.