A quick glance at newspaper headlines shows the uncertainty about oil prices. Phrases like, “Oil Prices Decline” sit side by side in a Google search with phrases such as, “Oil Prices Rebound.” What’s a commodities investor to make of all this?
The word volatility comes to mind. Over the past few years, oil has experienced a big downturn. Historically that should lead to a recovery. This time, however, recovery has been tentative at best.
Reasons To Be Optimistic
Those suggesting a rebound is around the corner cite solid global demand, new supply constraints and significant underinvestment. These bulls suggest now is the time to invest in oil for both income and for capital return.
The theory here is that higher oil prices will be the result of reduced inventories. Major producers just agreed to extend production cuts which should result in higher prices. One caveat – higher prices can push inflation higher and slow down economic activity.
Another reason for an expectation of rising prices and profits in oil relates to the U.S. shale industry. Although recent production restrictions by OPEC nations was widely seen as an opportunity for U.S. shale producers, it failed to take into account some problems the industry faces.
A number of U.S. producers are cash-flow negative. They need funding from banks and from investors to provide the cash they need to continue operating. Available personnel and equipment have, in many cases, slowed down production – just when it is needed most. Moreover, the same low prices that hurt overseas oil production have the same impact on U.S. production.
And The Bears Say …
Disappointment breeds disappointment. Oil prices tumbled 5% last Thursday after OPEC agreed to only renew an agreement to cap output by 1.8 million barrels a day until March 2018, a move seen as inadequate. Despite concerns expressed above, U.S. shale has experienced a resurgence and that resurgence is widely seen as blotting out OPEC efforts. In short, investors were hoping for deeper cuts by OPEC.
The return of an oil glut is seen as a very real possibility. If prices are determined by inventories, U.S. shale rises to the challenge and said oil glut happens as predicted, prices could plunge even more, say the bears.
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Long Term More Of The Same
When taking a longer view, prices appear to be headed for the $55 range according to Goldman Sachs. Goldman’s view is that prices will rise and fall sporadically but ultimately settle between $55 and $65 thanks to emergence of fracking. Oil from fracking wells is priced in that range and Goldman sees this as the new technology that will drive prices moving forward.
All this points to large shale producers as the future of oil. These companies include EOG Resources (NYSE:EOGC), Pioneer Natural Resources (NYSE:PXDC), ExxonMobil (NYSE:XOMD) and Whiting Petroleum (NYSE:WLLC) to name just a few.