On June 1, 2021, Jeremy Schwartz, Global Head of Research at WisdomTree and regular host of the Behind the Markets podcast, was joined by Mobeen Tahir, Associate Director of Research at WisdomTree, to welcome Erik Gilje, Professor of Finance at the University of Wharton School of Business in Pennsylvania. The topic was petroleum, and the focus was on Erik bullish view of the merchandise resulting from structural supply issues in the United States against a backdrop of improving demand prospects.
Professor Gilje pointed out that in the last decade almost all new oil supplies have come from North America, i.e. Canada or the United States, while the Organization of Countries oil exporters and its partners (OPEC +) have lost market share. The group has been forced by the COVID-19 pandemic to cut 9.7 million barrels of supply in what can be described as dramatic and unprecedented political coordination.
But OPEC + may not necessarily be obsessed with getting this offering back to service quickly. Indeed, the group is perhaps less worried about losing more market share to the benefit of American shale producers today than in the past. This marks a major shift in the dynamics between the two and could be the key force pushing the oil markets higher.
According to Professor Gilje, American shale production is drastically reduced and this is due to structural reasons. When West Texas Intermediate (WTI) oil was around $ 70 a barrel in 2018, there were 874 oil rigs in the United States. Today, there are 359. Similarly, the number of hydraulic fracturing teams in operation at the time was 485 compared to 226 today. Investments in US shale have fallen significantly and US oil production is expected to decline over the next 1 to 2 years, according to the professor.
But why could the reduction in investment be structural rather than fleeting and linked to the pandemic? Professor Gilje cited a change in investor preferences and government position as the two key factors. Investors who have not received dividends of American shale producers over the past decade now impose a stricter cost on their capital. They not only demand capital expenditure from producers, but also want them to have positive cash flow. Investors seeking carbon neutrality also pose more difficult questions to oil producers, which further increases their cost of capital.
The change in government position under President Biden is also remarkable. Biden’s freeze on hydrocarbon rights of way on federal lands limits new pipeline capacity and increases break-even costs for oil producers.
So even though the number of platforms has increased slightly in recent weeks, it is unlikely that pre-pandemic production levels will be restored, as there may be a 15-20% downgrade when bringing back online. platforms. This means that in order for production to remain stable, new wells must be dug, which seems difficult given the higher cost of capital.
Due to this evolutionary dynamic, it is unlikely that OPEC + will rush to put the offer back online, given the difficulties encountered by American producers. They should allow prices to rise amid improving demand prospects. Oil prices at $ 100 a barrel over the next 6 to 12 months may not be out of the realm of possibility.
Please listen to the full conversation below.
Originally published by WisdomTree, 6/8/21
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