Confidence returns to the oil patch, but some clouds linger

By Bryan Livingston
Managing Partner and CEO

With OPEC slashing output and the Trump administration signaling that it might roll back trade tariffs against China, oil prices are rising again.

Price improvements could boost involvement in the Permian Basin, where the quality of shale rock is considered superior to other North American shale basins.

Globally, the price of oil is on the uptick due to OPEC’s cuts. The Organization of Petroleum Exporting Countries announced on Jan. 17 that its production is the lowest it’s been in two years. OPEC cut production in December 2018 by 751,000 barrels per day, with Saudi Arabia leading the way with a decline in production of 468,000 bpd. OPEC reached a deal with 10 nations to reduce output by 1.2 million bpd beginning in January 2019.

In the United States, new pipelines will come online this year to get oil from the vast Permian Basin in West Texas to refineries and export terminals along the Gulf Coast —good news for E&P companies that are active in the Permian Basin.

A few notes of concern for the energy sector

While the climate for the global oil industry and the U.S. market are generally positive, new statistics from the U.S. government suggest supply-demand bears watching. The Energy Information Administration said Jan. 16 that the nation’s crude oil stockpile fell more than expected, while gasoline inventories rose more than forecast.

For the year, U.S. crude oil production averaged 10.9 million bpd in 2018, up 1.6 million b/d from 2017, according to the U.S. Energy Information Administration. The EIA expects U.S. crude production to grow this year to 12.1 million bpd, with most of that production coming from the Permian Basin in Texas and New Mexico.

The Dallas Federal Reserve’s Energy Survey showed oil & gas firms entered 2019 with heightened uncertainty and a bit of pessimism.

Growth in the energy sector slowed significantly in the fourth quarter, according to executives who responded to the Fed’s survey. The survey’s business activity index, the broadest measure of conditions among energy firms operating in the 11th District, which includes the PermianBasin, remained positive, but barely so. The survey was taken between Dec. 12 and Dec. 20, when the equity markets were experiencing a lot of volatility.

“While activity remains at a high level, growth stalled in the fourth quarter, and survey respondents reported much greater uncertainty surrounding their outlook,” said Dallas Fed Senior Economist Michael D. Plante.

U.S. supply could be constrained this year as E&Ps tamp down plans for CapEx, a move that could stabilize prices and edge them upward.

Reponses about CapEx for those operating in the 11thDistrict were mixed, with 37 percent of executives expecting a slight increase in CapEx and 16 percent anticipating a significant increase. However, 17 percent expect their firm’s capital spending to decrease slightly and 13 percent anticipate a significant decrease. About 17 percent expect CapEx to remain near 2018 levels.

A look at oil prices and what they might do

A potential slowing of CapEx and more intense control of expenses by E&Ps could lead to a better pricing climate this year.

West Texas Intermediate has been trading at around $52 a barrel in mid-January, down about 30 percent from its peak in 2018, but strong enough for companies to make a profit. We expect WTI’s price discount to Brent to continue to narrow this year and into next. Brent was trading at about $61 a barrel when this blog post was written.

Many of the predictions for 2019 pricing were made while oil prices were collapsing in late 2018, and we believe trader activity obscured global supply-demand fundamentals, which we believe are healthy. Supply constraints in Iran, Libya, Nigeria and Venezuela should help keep supply-demand in balance, even if production rises as expected in the United States. Venezuela’s oil production collapsed during the second half of 2018, and there aren’t any immediate signs of improvement, especially with the prospect of U.S. sanctions.

Declining oil inventories coupled with world demand could begin to outstrip supply by the middle of the year, driving prices upward during the second half of 2019. We think oil prices will rise higher than most people currently think, as world demand continues to rise.

Still, there are some caveats. The prospect of slowing world economic growth could negatively impact oil prices. At home, the geo-political situation — a divided Congress, a protracted partial government shutdown, an ongoing special counsel investigation of President Trump and trade wars — add uncertainty.

Despite these uncertainties, rebounding oil prices, new pipelines to come online later in the year, and a focus on high quality shale extraction suggest a year of change and an improving climate for the U.S. energy sector.

Capital Alliance Corporation is a Dallas-based investment banking firm with an extensive international reach and a 40+ year history of providing trustworthy advice to private company shareholders who want to sell their businesses. Our team has deep operational and M&A experience across many sectors, including energy infrastructure.

Industry: Energy