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Unsustainably high oil prices to fall back to $55

Jeffrey Stafford, CFA  |  28 Jun 2018Text size  Decrease  Increase  |  
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Oil prices are unsustainably high and have stretched valuations but crude prices will eventually retreat by up to 20 per cent to $55 a barrel.

Oil prices have pulled back some from highs above $70 per barrel of West Texas Intermediate in May but we expect them to fall further in the long run. We project a 2022 midcycle price of US$55 per barrel for WTI, US$60 per barrel Brent, which would represent a 20 per cent decline from today. Our forecast also puts us 10 per cent below long-term consensus.

As expected, our cautious stance on oil translates to much of our energy coverage trading above fair value. Still, some pockets of opportunity remain, particularly in the volume-driven midstream space.

OPEC and its partners announced on June 22 a deal to effectively increase crude production by 600,000 barrels a day beginning in the third quarter, which will serve to partially reverse the 1.8 million barrels of oil per day of production cuts that had been in place since the first quarter of 2017. The organisation is actually targeting 1 million barrels of oil per day of incremental production, but not every participant will be able to meet the call right away.

Some OPEC members, including Iran and Venezuela, are having difficulties reaching assigned targets due to US economic sanctions, and in the case of the latter, a general economic collapse. OPEC's cuts have largely served their purpose, and oil inventories have shrunk considerably in the past several quarters. We had always projected that OPEC and its partners would eventually turn the spigots back on, given OPEC's lack of history sustaining longer-term production cuts.

As such, the June 22 OPEC meeting did nothing to change our long-term outlook for global oil prices. We still forecast a 2022 crude price of $55 per barrel for WTI and $60 barrel for Brent. This sits roughly 10 per cent below current 2022 WTI consensus and 20 per cent below current prices, even after prices have retreated somewhat after the recent change in production strategy from Saudi Arabia and Russia.

Morningstar Australia senior equity analyst Mark Taylor agrees $60 a barrel is the "sweet spot" where the world gets adequate supply. "The price is sufficient to encourage enough new capacity to meet new growth in consumption," Taylor says. "But you're not overstimulating places like the US where shale can very easily make a big difference in the world in terms of production."

US shale is the marginal source of production in Morningstar's global framework. We contend that other potential marginal sources, including Canadian oil sands and offshore projects, will need to match US shale costs or risk being competed out of existence. We expect that upcoming offshore projects will, on average, best US shale, while oil sands production will sit above shale.

Though it's important to note that costs differ for each type of supply. For example, the best Permian wells drilled in the future are likely to sit well below other marginal sources of supply.

 

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Jeffrey Stafford, CFA, is director of energy & utilities at Morningstar US.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

Jeffrey Stafford, CFA, is an equity analyst for Morningstar, covering agriculture and chemical companies.

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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