Where Are Oil Prices Heading as We Approach 2020?
September 9, 2019

In our last review of oil markets and impacts on energy producers (view here), we provided arguments for both the bull and bear thesis. It is a few months later and we are now witnessing the bear thesis play out given the level of turbulence in today’s market. 

Looking ahead to 2020, we have little confidence that oil prices will be any better than they are today. That may be a best-case scenario given the level of turbulence in the markets today and likely looking out to the remainder of 2019. Oil prices have dropped 8% in a single day, purely based on a tweet, suggesting that fundamentals currently have little bearing on the movement, either up or down, on oil prices. The trade war with China could quite conceivably linger on until after the next presidential election; oil demand growth at its lowest level since 2008 and likely to continue to slide. Growth projections for significant world economies looking gloomier by the day, add the uncertainty around a “hard” Brexit, and it all adds up to a whole heap of uncertainty.

SO, HOW DO OIL PRODUCERS DEVELOP CAPITAL & OPERATING BUDGETS FOR THE YEAR AHEAD WITH ANY LEVEL OF CERTAINTY?

The confidence must emanate from within; operators must look to optimize every dollar of spend and deliver every potential barrel of hydrocarbons.  Even at sub-$50 oil, it is possible to generate high levels of profitability and free cash flow.

Since the March publication, we have not changed our position on the bear thesis, as there has been little change in the drivers pushing the bear thesis. We wrote that the bullish thesis unravels on an increasing number of current and potential challenges that could take oil back into the $40s. Not least of which is the continuing strength of the US Dollar. A strong dollar will create downward pressure for oil prices.  The European Central Bank (ECB) holding rates for the remainder of 2019 to try and stimulate a lackluster EU economy,  provides more fuel for the continuing strength of the US dollar.

Add to that mix, the pressure on the Chinese currency. Whether it is the markets driving down the Yaun, or the Chinese government devaluing their currency to offset tariffs, is best left for the conspiracy theorists. What we do know is that the Yuan is now trading in the +7 territory, and likely to be range-bound given the current trade dispute.

There are many reasons why the US Dollar remains an attractive currency haven. Not least of which is the GB pound at near historic lows given that Britain is careering at speed towards a hard Brexit. The US/China trade dispute could easily linger on until after the next US Presidential election, with serious implications not just for the US and Chinese economies, but the global economy, further weakening demand for oil. The rhetoric, as well as the tit-for-tat actions from the trade dispute, continue to erode confidence in the markets.

Asian demand has been a central driver for oil prices for some time, with the rapid growth of key Asian economies of China, India, Japan, and South Korea. As we mentioned previously, there is likely to be a continued downward demand in Asia with manufacturing output continuing to slide. Factory orders and utilization data all advance to the negative side. The continuing geopolitical tensions between India and Pakistan could easily continue to escalate dampening confidence in the respective economies and add further downward pressure on growth and ultimately demand.

Another scenario is the impact on oil prices if the Chinese decide to buy Iranian crude that is reported to be stored in Chinese ports, estimates indicate that could be as much as 12-14 million barrels of oil. Merrill Lynch stated that crude prices could sink by as much as $30 a barrel if the Chinese decide to buy that Iranian crude. Add to the mix the fact that current sanctions have limited Iranian exports to just over 500,000 barrels per day in June, not forgetting that a year earlier, Iran was producing something close to 2.5 million barrels per day, a level that presumably they can quickly ramp back up to if and when we see easing of sanctions, and they again have access to international markets, a level that would be a cut too deep even for OPEC to try and maintain the current supply balance.

The picture looks a little bleak, but equally of concern is that events that are traditionally positive drivers for oil prices are seeming to have little impact or bearing on current markets. We have seen OPEC, and Russia not only agree and stick to production cuts, but they are also discussing the possibility of extending production cuts. Further production cuts could help buoy oil prices. We have seen a significant drawdown of stockpiles in both the US and Europe. We are partway through the turnaround season for refineries in the South, as well as driving season in the US. The impact of all of these events has been minimal at best as oil prices continue to slide or trade sideways.

Amongst this gloomy backdrop, we must not forget that there has been considerable monetary support from central banks including the ECB and the Fed, helping contain some of the downsides, but certainly not enough to drive the markets to levels seen earlier this year and particularly the peak that we saw in April.

Moreover, with several analysts and institutions suggesting the heightened likelihood of a potential slide into a global recession in Q4 or early 2020, we conclude that there are too many negative factors currently at play for producers to not plan for the bear case oil scenario for the remainder of 2019 and 2020.

HOW DOES THIS LEVEL OF UNCERTAINTY AFFECT PLANNING & BUDGETING?

We continue to maintain the position that Shale producers should still be profitable and cashflow positive with prices even as low as $40 per barrel. It comes down to driving efficiency and effectiveness in the execution of capital projects (particularly drilling and completions) and operations. Over the years, oil producers have made significant strides in driving down costs and increasing efficiencies. Moreover, year on year, they continue to make progress as new technology adds speed and certainty, aligned with the continued streamlining of internal processes and structures. The key challenge for producers is learning how to optimize operations given new technologies available not just today but in the very near-term, especially with the growth in the field of remote operations. What does that mean for organizational structures, training & development, recruitment, retention, operating philosophies? These are critical areas for improvement, given the continuing need to operate and produce more with less. Addressing these are challenges will drive the next round of organizational and operational cost advantages.