Taal selectie

Oil

Shale is the name of the game

The oil price plummeted more than 20% in November, ending the month at USD 50.93 per barrel (WTI). The XOP index of US shale producers fell 9%, while our selection of companies lost 8.5%.

Why such a correction and is this low oil price temporary or here to stay?

shaleOil VsWTISource : Bloomberg

Although the crude price continued to weaken during the first week of November, losing another 8% to USD 60.19 per barrel, shale oil stock prices stabilised.

Last spring, President Trump announced that he would reinstate sanctions against Iran and “take Iranian exports to zero” from November onwards. He later had a sudden change of mind and granted Iran permission to continue exporting oil to its major clients for six additional months.

In plain language: the 1.5 to 1.8 million barrels/day that were expected to leave the market are still in place, even as OPEC and Russian production has been ramped up by over 1.5 mln barrels/day to avoid a supply shock.

The market thus moved at once from an equilibrium situation into oversupply, at a time when “everybody” was betting on a further increase of the oil price. Hedge funds and oil producers were caught off guard and had to sell (massively) their futures or hedge (part of) their future production, causing the crash in the oil price.

This of course hurt stock prices of shale oil producers, which posted a second consecutive monthly decline, albeit less than the oil price itself. (There is a high correlation between the oil price and shale producer share prices – see chart)

What next?

We do find it frightening to see how a 1 or 2 million barrel difference (in either direction) on a total daily production of some 100 million barrels can move the oil price so much (oil has fluctuated between roughly USD 50 and USD 80 this year in a relatively stable demand environment). Such volatility is likely to persist for maybe another year or two, until the market becomes fundamentally undersupplied and political decisions (be they Trump’s or OPEC/Russia’s) no longer matter.

In the short term it is reasonable to expect that OPEC and Russia will implement production cuts to bring the market back to equilibrium, but this could take a couple of months. Announcing such a decision could already bring some relief to the market and, with it, a higher and more reasonable oil price of, say, USD 65 per barrel. And one never knows with Trump… what if he changes his mind again on Iran?

(Update : 12.2018)

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