Energy: No Rapid Rebound for Oil Prices

• Although we continue to believe that crude oil prices are well below the levels required to incentivize sufficient investment to meet demand beyond 2017, our long-term price outlook has fallen to $70 Brent and $64 WTI, reflecting abundant low-cost supply and industrywide cost deflation. Industry oversupply is making it very likely that crude markets will not approach any semblance of normalcy until 2017.
• Cost-advantaged resources have continued growing in recent quarters despite the slump in prices, thanks to ongoing productivity improvements across U.S. tight oil plays as well as sanctions relief that will result from the Iranian nuclear deal. Longer term, this makes it likely that low-cost oil will continue to crowd out more marginal projects that were being sanctioned prior to oil prices collapsing.
• Further, our originally anticipated point of global supply and demand coming into balance has continued to get pushed further into the future as this year has progressed. This, in turn, has led to a collapse in near-term investment that has increased the magnitude of cost deflation and has considerably weakened the currencies of many commodity-exporting countries. The result is lowered break-even levels for both offshore and oil sands projects, which we expect will be the resources setting the industry's marginal cost once crude markets have rebalanced.
• 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. Abundant supply is holding current prices low, but in the long run we anticipate relief from incremental demand from LNG exports as well as industry. Our midcycle U.S. natural gas price estimate is $4/mcf.

Given both its remaining growth potential and ability to scale up and down activity quickly, tight oil has effectively made the United States the world's newest swing producer. Drastic spending cuts will lead to a meaningful decline in near-term production, but the strong economics of the major U.S. liquids plays means production will begin growing again as soon as oil prices recover.

Meanwhile, demand tailwinds from exports and industrial consumption will help balance the domestic gas market eventually, but ongoing cost pressures from efficiency gains and excess services capacity--as well as the crowding out of higher-cost production by world-class resources such as the Marcellus Shale and associated volumes from oil-rich areas such as the Eagle Ford and Permian--are weighing on near-term prices. Even under these circumstances, however, undervalued, cost-advantaged investment opportunities remain.

Continental Resources

CLR

Continental is our top pick within the U.S. oil-focused exploration and production group. Continental played a key role in the early development of the Bakken Shale and now holds 1.2 million net acres prospective in this prolific oil play. More recently, the company has added a second string to its bow with the ongoing delineation of the South Central Oklahoma Oil Play). Even at today's prices wells drilled in these areas offer attractive returns, and Continental's positions will take at least 20 years to work through. The firm has a strong liquidity reserve and will be free cash flow neutral in 2016.

ExxonMobil

XOM

We view ExxonMobil as offering the best combination of value, quality, and defensiveness. Exxon will see its portfolio mix shift to liquids pricing as gas volumes decline and as new oil and liquefied natural gas projects start production. The company historically set itself apart from the other majors as a superior capital allocator and operator, delivering higher returns on capital than its peers as a result.

Cabot Oil & Gas

COG

On the gas side, Cabot controls more than a decade of highly productive, low-cost drilling inventory targeting the dry gas Marcellus Shale in Pennsylvania. Fully loaded cash break-even costs are less than $2.50 per mcf.

More Quarter-End Insights

• Stock Market Outlook: Minor Correction Not Enough to Make Stocks Cheap
• Economic Outlook: As World Growth Falters, the U.S. Consumer Rolls Along
• Credit Markets: Plummeting Commodity Prices Take Their Toll
• Basic Materials: U.S. Construction Activity Provides Shelter From the Storm
• Consumer Cyclical: Near-Term Concerns Over China Create Buying Opportunities
• Consumer Defensive: Upside in Staples Companies With Long-Term Cost-Cutting Opportunities
• Financial Services: Re-Analyzing Banking Systems and Bank Moats
• Health Care: Recent Pullback Opens Door to More Compelling Valuations
• Industrials: High-Quality Industrials Are on Sale
• Real Estate: For the Strong Stomached, Commercial Real Estate Looking More Attractive
• Tech and Telecom: Still Watching Foreign Exchange Headwinds and the Cloud
• Utilities: Low Rates Keep the Sector's Lovefest Raging