Adapting to lower for longer oil prices

The strongest of them can now resist low oil prices while keeping their ability to re-start growth quicker than others. This view also leads us to a preference for companies that provide services to those onshore players, in the form of rigs, pressure pumping, sands, pumps or chemicals.

From a cost-curve perspective, we think that US onshore resources are likely to displace ultra-deepwater and oil sands in the near-term. We are therefore avoiding exposure to anything related to those activities being from a resources’ holder or service perspective.

The drop in the oil price poses multiple challenges worldwide. Unless the oil price rises above USD/60bbl, US oil production will likely drop by the end of 2015 and into 2016. US conventional oil, which accounts for about half of US production, is already in decline. And declines continue in Mexico, Venezuela, Colombia, Nigeria while Brazil has lowered its production outlook as far as 2020. Multiples projects have been delayed/cancelled in deepwater and oil sands.

Putting aside the volatility around the Lehman crisis, 2015 is likely to be the strongest year in terms of oil demand in a decade thanks to the boost from low prices. 2016 is also shaping up as a strong year in terms of oil demand growth.

Looking ahead to 2016, we therefore see a rebalancing of the oil market. In addition, given the fight for market share within the OPEC countries, we calculate that their spare capacities will have dropped to about 2% of global demand by the end of 2016, the lowest levels in a decade. Could US onshore players by then be flexible producers swiftly matching market requirements? This is an important question.

As time passes, oil services companies’ ability to re-hire thousands of laid-off people is diminishing as they find jobs outside the sector. Equipment inventories are also being run down. We think it would take 8-12 months for US onshore players to be able to respond to any sufficiently-convincing oil price hike. Such dynamics are laying the ground for a potential very volatile oil price environment.

Only a successful peace process in Libya and/or a major emerging markets dislocation could derail those dynamics. And we don’t think such scenarios, for now, are likely.