Last November, we published a white paper, Taking Advantage of Energy Reflation, that laid out the need for the re-start of the U.S. shale machine to plug the emerging global oil supply “gap” into 2020. Since then, OPEC has cut supply by over 1.5 million barrels per day (bpd) and global GDP trends have improved. Yet recent U.S. storage data has come in higher than expected, catalyzing commodity trader anxiety and resulting in a crude oil price sell-off to below $50/bbl.
Take a deep breath. The rebalancing of the oil markets was never going to be smooth sailing, and we believe that traders’ overwhelming focus on several weeks of U.S. inventory data is short-sighted. Keep in mind that U.S. crude stockpiles (excluding the Strategic Petroleum Reserve, SPR) represent only about 10% of the global inventory picture. Furthermore, we can point to several causes of these above-average storage builds that are likely to reverse course in the months ahead. First, U.S. refineries are in the midst of maintenance season which temporarily curtails crude demand by over 1 million bbls per day from normal run-rates during the summer. Secondly, the shipping lag time for crude tankers means that pre-OPEC cut supply from late last year was still hitting the U.S. shores last month. And finally, the flattening of the oil futures strip since the start of the year dissolves crude storage economics for offshore terminals and forces those barrels into less expensive onshore regions like the U.S. Most importantly, global oil demand is seasonal by nature, with demand typically 1.5 million to 2 million bpd higher during the second half of the year relative to the first half.
While many remain absorbed by the short-term volatility of oil prices, the multi-year view of oil market fundamentals remains far more important to the structural tailwinds of the U.S. energy reflation theme. With budgeting season now behind us, the International Energy Agency (IEA) is forecasting global upstream investment of around $450 billion this year. While this is an increase from 2016, the IEA believes this is still 25% below the spending level necessary to offset mature field declines and meet continued demand growth. For some perspective, the consulting firm Spears & Associates expects the entirety of North American onshore oil and gas spending to reach $109 billion in 2017 – so the implication is that a doubling of this figure, of which shale is only a portion, wouldn’t even be enough to bridge that $150 billion annual global spending shortfall.
U.S. Shale Set to Take Market Share
The advent of new drilling and completion technologies has driven down the development cost for U.S. shale producers to a much more competitive level within the global oil supply curve. Another important benefit of U.S. shale is the much shorter cycle development time versus bigger international and offshore oil projects. For example, consider that industry analysts covering four of the largest publicly traded independent E&Ps – Continental Resources (NYSE: CLR), Concho Resources (NYSE: CXO), EOG Resources (NYSE: EOG), and Pioneer Natural Resources (NYSE: PXD), which together represent a little over 10% of all U.S. shale production today – model the ability to add a combined 1 million bbls per day of new oil supply over the next four years at only $55/bbl.
ExxonMobil (NYSE: XOM), the largest energy company in the world, is a clear example of this market share trend. Despite cutting worldwide upstream spending by over 40%, the amount of annual investment dollars the company is directing to the U.S. through the end of the decade is actually unchanged. Exxon’s short-cycle Permian and Bakken regions now represent over 50% of its entire global upstream drilling campaign. In fact, Exxon is expanding across the panorama of the energy value change through $20 billion of U.S. Gulf Coast “manufacturing” (meaning refining and petrochemical complexes) investment over the next decade. Not to be outdone, the second largest U.S.-based energy company, Chevron Corporation (NYSE: CVX), plans to at least double its Permian volumes over the next three years.
Investing with the Horizon in Sight
While near-term energy price volatility is sure to be driven by the unpredictable ebbs and flows of sentiment stirred by the most recent headline, our fundamental analysis suggests a high probability that energy pricing, capital investment and volumes must reflate over the coming years. More specifically, we believe that U.S. shale will play a dominant role in the re-emergence of the energy markets from one of the harshest down-cycles in history. Notably, we believe the SteelPath midstream-focused funds are positioned to benefit from the resultant increase in transportation and storage demand that should accompany shale production growth. Further, just as Exxon sees opportunity across the energy value chain, the SteelPath Panoramic Fund is designed to exploit these dynamics through broad investment across the panorama of the energy sector including midstream, upstream, service providers, and feedstock consumers (e.g.; refiners, chemical companies).
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As of February 28, 2017 Oppenheimer SteelPath Panoramic Fund held a 0% position in Continental Resources (NYSE: CLR), 3.35% in Concho Resources (NYSE: CXO), 2.31% in EOG Resources (NYSE: EOG), 3.22% in Pioneer Natural Resources (NYSE: PXD), 0% in ExxonMobil (NYSE: XOM), and 1.84% in Chevron Corporation (NYSE: CVX).
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