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Oil Price Commentary: 2016 will continue to be a transitional year, not least because there likely to continue to be casualties, but we believe that it will also be the year that sees the start of what we have previously stated that “this leg will be seen as a relatively short lived down leg in the context of an upward saw tooth growth pattern,” but the one thing you can always guarantee with oil price estimates, that they will be wrong – its more about the direction.
In Brief:
Andes Energia (LON:AEN – 15p) – Progress Being Made
Ascent Resources (LON:AST – 1.25p) – Outlook Improving
Jupiter Energy (LON:JPRL – 11p/A$0.25) – Operations Update
Oil Market Commentary
The futures continue to support higher prices, (up to ~$60/bbl in Feb 2023), a fact which has been supported further by spot prices sustaining averages above ~$45/bbl more recently. While the number of US onshore rigs has continued to decline, we have a growing belief that the rapidity at the which the US rig can commission and stack rigs, and Saudi Arabia’s intention to maintain production at current levels, is cementing the US’ role as swing producer, governed by the only credible regulator, i.e. market forces, opposed to wilful political or ad-hoc manipulation.
This has had a noticeable effect on the US onshore market, as the application of free market economics has resulted in an increasingly lean, very efficient and agile US onshore oil market, such that the perceived breakeven of shale producers of ~$60/bbl, is now generally accepted to be materially lower, in some instances as low as $35.bbl.
While Iran and the rest of OPEC are in disarray, there is significant impetus behind raising production from current levels, and as such, in the near term, until this has been quantified, there is unlikely to be too much pressure to bring the US rigs back on line, and the decline in US production will therefore accelerate, it will further cement the US’ role as the swing producer.
The lower costs associated with US unconventional production, while it hasn’t changed the market, it has acted as a dampener to the decline in supply side volumes. The near term impact has been to retard the recovery in the oil price, but it is in the longer term that this effect will be more acutely felt.
While there are many variables that impact the oil price, we are reiterating our belief that the supply side isn't as robust as people believe it is, and this is only exacerbated the further out you look. We have often stated that there is a scenario that says that within two years the market is going to be worried about bringing on the projects that were shelved in this price environment because there is a perceived shortfall.
While we have focused on supply, our recovery has assumed that that demand remains at current levels. What is a real unknown, especially at the moment, is the demand side of the equation. Again, here too history would generally support higher prices as oil demand is an inelastic driver (as it used in so many things from household plastics through to transport fuels) the real question is going to be to what extent global growth accelerates from these levels. Changes in demand tend to vary between -5% and +5%, with the extremes of decline only precipitating from catastrophic contraction in GDP.
If we balance this against the fact that supply will naturally decline at between 8 to 10% if no investment is made, then on balance, the further out we look, assuming we the current investment activity for the near term, then the supply imbalance will become excessive. However, we also accept that this imbalance is not quantitative, but qualitative, they market will have to perceive that there is a looming shortfall for it to impact the oil price. We believe that the next few quarters will see continuation of volatility in the oil price, but towards the end of 1H’17, we expect to see that translate in to an upwards “saw tooth” progression.
While like all people in industry we’re concerned about the current price environment, but we are less concerned about the oversupply in the marketplace beyond 9 to 12 months, simply because the contraction in investment will see the natural decline rate associated with existing production start to impact the overall supply levels. It is important to remember that this is distinctly different from nameplate capacity, and is set at the front end engineering and design stage.
2016 will continue to be a transitional year, not least because there likely to continue to be casualties, but we believe that it will also be the year that sees the start of what we have previously stated that “this leg will be seen as a relatively short lived down leg in the context of an upward saw tooth growth pattern,” but the one thing you can always guarantee with oil price estimates, that they will be wrong – its more about the direction.
In Brief
• Andes Energia (LON:AEN – 15p) – Progress Being Made: Today's news underlines the progress that the Company continues to make on all fronts, not only growing revenues, but reducing costs. We believe that the Company's outlook remains bright, and it will emerge from this period of low oil prices w oil prices in a stronger position than when it entered them. Obviously the only caveat is the Argentinian country risk, but here too, we are becoming increasingly impressed in the way that Marci is dragging the country forwards, but we will wait until his administration exist the “honeymoon” period before changing our opinion wholesale. Investors should be pleased with the way the Company is progressing.
• Ascent Resources (LON:AST – 1.25p) – Outlook Improving: With these results the Company's narrative is more important than the underlying numbers, although the reduction in costs while the Company is in this phase is welcome. Given that an alternative route to valorisation of the asset is now close, we believe that the pressure that has been on the shares is now likely to start to reverse, and although there is likely to be a funding round at some point in the future, we are confident that there will be some element of credit extended to cover the project’s cost, and so will not be as large as would be expected, and hence conducted from a higher level. We believe investors should be pleased with the progress that the Management team have made to date, and the direction that the Company is now moving in to develop the asset base.
• Jupiter Energy (LON:JPRL – 11p/A$0.25) – Operations Update: Today's results reflect Management's approach during this period of lower prices, that progress will be measured and aimed at preserving the cash resources until such times as its economic to move forwards. With the brightening outlook, the Company's approach is now likely to minimise the funding gap that will inevitably result, and although this fact will weigh on the shares, we believe this should be counterbalanced by the prospect of cash generation from the trial production. The net effect of these opposing effects will undermine the shares in the short term, but we believe that once the plan is more formally and fully articulated to the market, the net effect will be positive. We believe Management have coped admirably with the competing pressures, and for that, they deserve a lot of credit for the Company being a ble to be in a position to talk about the plan for 2017 and beyond.