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Quarter-End Insights

Energy: Coping With Lower Oil and Gas Prices

The rapid decline in oil prices has created significant investment opportunities, but downside risk remains in the short term.

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  • The United States has rapidly become the critical source of incremental supply for global oil markets, and growth has come overwhelmingly from unconventionals. The large increases in U.S. output did not upset global supply/demand balances, largely because significant amounts of supply were disrupted by political/security issues (for example, Libya and Iran). But in 2014 the scales finally tipped: Combined with weakening demand and OPEC's decision not to reduce its own production, major supply imbalances resulted that, as of today, have yet to dissipate.
  • In the current market environment of high costs/low oil prices, upstream firms face extremely challenged economics where new investment is not value-creative. Such conditions are not sustainable over the long term, however, and we expect the combination of rising oil prices and falling costs to provide significant relief in the coming years.
  • Despite our belief that tight oil has considerable running room from here, it can't completely meet future global demand. The marginal barrel, therefore, will come from higher up the global cost curve. Our forecasts show higher-quality deep-water projects will be the highest-cost source of supply needed during the rest of the decade. As a result of this meaningful move down the cost curve, we are lowering our Brent midcycle oil price forecast to $75/bbl (WTI: $69/bbl).
  • Although U.S. gas production is likely to slow in the near term as oil-directed drilling hits the brakes, the wealth of low-cost inventory in areas like the Marcellus points to continued growth through the end of this decade and beyond. Despite our expectation for continued growth in demand, there is more than enough low-cost supply to justify a reduction in our midcycle U.S. natural gas price estimate to $4/mcf from $5.40/mcf.

 

Dave Meats does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.