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- After crashing in March, the price of crude oil is recovering faster than banks initially predicted.
- Some producers that were forced to pare back oil production are already reversing cuts as a result.
- Still, don’t expect oil demand to fully recover before the end of next year, analysts say.
- It could take even longer before US production grows.
- For more stories like this, sign up here for our weekly energy newsletter, Power Line.
It was a devastating spring for oil markets, as some futures reached record lows and companies responded by laying off staff, slashing dividends, and cutting billions from annual budgets.
But now there’s some good news: The price of crude is rising fast — faster than investors expected.
The US benchmark, West Texas Intermediate (WTI), posted its sharpest monthly gains on record in May. And when markets opened Tuesday morning, just days after OPEC Plus agreed to extend record supply cuts through July, WTI was trading at about $38 a barrel — up another 8% or so, since the start of June.
“The oversupply, which sent WTI oil prices into the negative earlier this year, is a thing of the past, as long as OPEC+ compliance stays strong and the oil demand recovery trajectory isn’t radically altered,” the research firm Rystad Energy said in a statement on Monday.
Depressed supply and returning demand for oil-based fuels, such as gasoline, are driving the market recovery, analysts said.
Data on mobility from Apple Maps, for example, suggests that requests for driving directions — a rough proxy for travel volume — have returned to pre-pandemic levels in the US. Routing requests are also recovering in Germany and Italy, the data show.
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“The balance between supply and demand continues to tighten, after rebalancing earlier than expected,” Morgan Stanley analysts led by Martijn Rats said in a note on Monday. “From here, demand is set to improve as economies re-open.”
Demand could fully recover by the end of 2021, Morgan Stanley says
To understand the near-term future of oil markets, it can be helpful to look to China, where the coronavirus hit first.
There, a recovery is well underway and traffic has picked up. That translates to growth in oil demand: In May, the country imported a record volume of crude oil, according to a UBS note published Monday.
Surging demand in China and elsewhere has helped sentiment for the sector, the UBS analysts note. But Rats says that demand “still seems fragile.”
Look at refining margins, he says, which are historically low. In fact, Morgan Stanley’s global composite of refining margins is in “negative territory,” the bank said.
“Demand is unlikely to return fully to pre-COVID-19 levels until the end of 2021, in our view,” Rats said.
Analysts at Goldman Sachs led by Damien Courvalin shared similar concerns. In a note published Monday, they said that “demand expectations are running ahead of a more gradual and still highly uncertain recovery.”
What returning demand means for future prices, and what those prices mean for oil producers
So far, most banks have underestimated the speed at which oil prices have recovered.
Goldman Sachs now predicts WTI will be priced at $40 a barrel in the last three months of the year, up from the bank’s previous estimate of about $35.
In a note published Friday, Morgan Stanley says that under a “base case” scenario, it expects US crude oil to trade for about $35 a barrel for the remainder of the year and breach $40 in mid-2021.
That tracks with the current price of US crude for delivery 12 months from now, which is selling for about $41 a barrel, per Morgan Stanley.
And $40 is an important number. According to Rats, it “marks the tipping point between growth and decline in US shale.”
Companies that hedge their oil output use 12-month futures — currently above $40 a barrel — to lock in prices, he writes. That means companies could theoretically lock in prices now that will support growth next year.
Current prices are reversing shut-ins, but that doesn’t mean production is set to grow
Cheap oil forces producers to curtail production, such as by shutting in wells or choking output. At prices well below $40 a barrel, extracting crude just isn’t profitable.
That’s why, in May, US and Canadian producers cut oil production by as much as 2.5 million barrels per day (bpd), Bank of America analysts said in a note published in late May.
But with WTI nearing $40 a barrel, some producers are starting to reverse those cuts.
EOG Resources, for example, “plans to slowly begin reversing curtailments” next month, amounting to 125,000 bpd, while WPX energy has started bringing back 45,000 bpd, Morgan Stanley said.
“There is no longer an economic incentive for shut-ins,” Rats said.
In fact, during recent earnings calls, producers mentioned that they’d be willing to reverse curtailments at prices between $25 and $35 a barrel, which is already below the price of WTI.
Still, while some companies may be restarting wells, total output will likely remain down through the end of the year, due to capital spending cuts, analysts at multiple banks said.
Capex cuts translate to reduced spending on drilling and completion activities, Bank of America analysts wrote. They expect oil production to be down about 2 million bpd in the last three months of the year, relative to the same period last year.
“On our estimates, there is little room for US production to grow this year or next,” Rats said.
Most notably, Rats concludes that US crude oil needs to stay at about $50 a barrel for two years for production to fully recover to pre-pandemic levels.
What a price recovery means for exploration and production stocks — and top stock picks
Companies focused on oil and gas exploration and production (E&P) have surged in market value in recent weeks.
Since the beginning of April, E&P stocks have rallied by about 75%, Morgan Stanley said, besting the broader energy sector.
In general, the bank favors “quality companies best positioned to efficiently restore the business.”
Restoring US production will take time, but several low-cost E&Ps are set to benefit as production comes back online, the analysts said. Those include ConocoPhillips, Parsley Energy, and Cimarex Energy.
The bank also notes that Hess Corp is rated favorably and “offers one of the most resilient long-term production and [free-cash-flow] growth outlooks, anchored on high return investments in Guyana.”
Meanwhile, in a note published last Friday, analysts at Goldman Sachs say the recent rally in prices has reduced investor confidence in both upside and downside scenarios.
However, the bank notes that “longer-term beneficiaries of higher prices” include Hess, in addition to Concho Resources and Pioneer Natural Resources.
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