Our Perspective on Those $100 Oil Forecasts

Is oil going to $100 per barrel? The consensus amongst financial commentators we follow increasingly appears to be yes, with forecasts now calling for West Texas Intermediate (WTI, the US benchmark) and Brent (global) crude oil prices to pass $100 or even $120 later this year—up from WTI’s current $90.27 and Brent’s $91.12.^[i] If those forecasts prove true, it would complete oil’s round trip to prices from before America’s shale boom vastly increased supply—making it no coincidence that supply concerns underpin those projections.^[ii] Virtually no financial commentators we follow, as far as we have seen, forecast oil production coming anywhere near pre-pandemic levels, which we think is a case of recency bias—in which people extrapolate what just happened far into the future. It seems to us these analysts are missing some underappreciated supply drivers, yet even if we are wrong and oil jumps high from here and stays there, we don’t think there is likely to be much economic (or market) impact. Stocks and the economy did fine with oil above $100 in most of 2011 – 2014, and they can probably do so again.^[iii]

The case for high oil rests on forecasters anticipating production will continue to crawl in North America and OPEC+ nations. The latter made headlines Wednesday for agreeing to proceed with a planned 400,000 barrel-per-day (bpd) production increase in March.^[iv] Yet as many financial commentators we follow have noted, the cartel and its partners have struggled to reach higher production targets in recent months.^[v] African producers are struggling, too.^[vi] Nigeria continues to contend with terrorist attacks on its oil infrastructure, whilst conflict and a political void in Libya leave the country with Africa’s biggest proven reserves idling.^[vii] Elsewhere, Russia is developing some new fields more slowly than expected, and Saudi Arabia—which has ample spare capacity—has declined to make up the shortfall.^[viii] Hence, according to a Wall Street Journal analysis of an internal OPEC report, the cartel missed its December target by 824,000 bpd.^[ix] Add in warnings of Russia potentially cutting oil exports to the EU—whether because of sanctions or sabre-rattling—and you get the spectre of a possible big shortage.

Thing is, our research finds these headwinds aren’t really new. OPEC+ participants have long struggled to meet quotas.^[x] Yes, the future of Russian exports to Europe is unpredictable, but the oil market is fully global. If Russia does stop supplying Europe, we think the market will simply shift. Perhaps that supply will go elsewhere—maybe China—whilst the US, North Sea, Middle East and North Africa, Canada and Brazil fill Europe’s shortfall. Oil, like water, always finds a way, and rising prices would be a strong incentive to ensure it does, in our view. Moreover, for all the attention OPEC+ receives, the cartel’s relevance has long been on the wane, largely because the US has become the world’s swing producer.^[xi] High prices encouraged booming US production a decade ago.^[xii] We think they can easily encourage producers to boost output again.

Actually, we think there is plenty of evidence they already are. The oil-to-$100 crowd notes production has been slow to recover from pandemic lows, and they don’t forecast that changing any time soon. Instead, they argue rising breakeven prices (due to higher labour and equipment costs) and impatient shareholders are incentivising oil producers to delay investment.^[xiii] (The breakeven price refers to the oil price necessary for a new well to recoup drillers’ upfront costs.) To that argument, well, we have some questions. If breakeven oil prices are such a deterrent, then why are Canadian producers projected to boost investment by 22% this year?^[xiv] Why is investment in Alberta, home to Canada’s oil sands—one of the costliest places to drill on the planet—projected to rise 24%?^[xv] Why is oil production in the US’s Permian Basin now heading to all-time highs above 5 million bpd?^[xvi] Why did America’s Bureau of Land Management approve 5,145 permits to drill on Federal and tribal land in fiscal 2021, plus another 511 in October and November?^[xvii] Oh, and why is that fiscal 2021 total higher than every year since 2008?^[xviii] Call us crazy, but we think that looks more comeback than cutback.

Another thing: Our research finds that one of the biggest reasons US oil production recovered slowly is that oil companies opted to pay down debt as prices rose last year—a byproduct of the debt financing accrued during the shale boom and the wave of bankruptcies in the industry when oil crashed in 2015 and 2016.^[xix] But now, according to the latest figures from S&P Global, US oil and gas exploration and production companies’ total net debt is down from $298 billion (£220.51 billion) in 2020 to $167 billion (£123.58 billion) today, a multiyear low.^[xx] Producers have seemingly taken their medicine. The industry has consolidated. Whilst we don’t think a flood of debt-fuelled investment is likely from here, we also don’t think there is much indication high debt is necessary to restore high production. Oil prices now are over $20 per barrel higher than in 2018 and 2019, when production soared to all-time highs.^[xxi] That makes drilling a lot more profitable than it was then, which we think should be enough to encourage more investment and production.

We don’t think any of this precludes short-term oil price spikes, especially with geopolitical tensions affecting sentiment.^[xxii] Yet in our view, oil’s January spike was likely markets pricing in the risk of Russian supply disruptions—similar to how stocks typically fall in the run up to regional conflict.^[xxiii] But as time rolls on and supply and demand come more into balance, we think oil prices will probably surprise the world by staying benign.

Even if they do breach $100, we don’t think there are many signs this would be so problematic. For one, a move to that Big Round Number amounts to a mere 12% rise in Brent prices from today’s levels.^[xxiv] We don’t think that is an enormous spike. Oh, and during the entire stretch from 2011 to 2014 when oil was north of $100, global stocks rose 40.2% and the MSCI UK rose 35.3%.^[xxv] US Gross Domestic Product (GDP, a government-produced measure of economic output) grew—slowly, in keeping with the 2009 – 2020 expansion’s norm—but grew nonetheless.^[xxvi] UK GDP followed a similar course.^[xxvii] The period ended with US shale producers and OPEC oversupplying the market, leading prices to tank.^[xxviii] Then financial commentators we follow warned low oil prices spelled trouble for stocks and the economy and the sentiment cycle turned anew.

Maybe, if oil breaches $100, the story doesn’t end exactly like 2011 – 2014 this time. But we think it is highly unlikely that and that alone would have the negative effect some seem to sweat.