OPEC's production cuts and strong demand growth have 2017 crude fundamentals in their best shape since oil prices crashed two years ago. The consensus outlook is that market fundamentals are now strong enough to remain healthy even after OPEC returns to higher production.
This might have been possible a few months ago, but the odds of this scenario playing out have since markedly worsened. The reason is that the major increases in shale activity now have U.S. oil production firmly on a path toward rapid growth, even if shale rig counts don't increase from current levels. This growth--plus the eventual production increases from OPEC--is likely to erase any market tightness and throw crude markets back into oversupply within the next six to 18 months.
Current oil prices provide economics that are very attractive to the major U.S. shale producers. This has created the conditions that will allow tight oil to grow rapidly and is a reality that even forthcoming cost inflation will not change. Unless shale producers become more disciplined or OPEC resigns itself to permanently ceding market share to U.S. producers--neither of which is likely to occur--oil markets have major problems looming on the horizon.
There remains a good chance that oil prices could rise further in the coming months if OPEC compliance remains high. Because surging shale production won't truly begin to move the supply needle until the second half of the year, OPEC discipline would allow for significant global inventory draws in the interim. This could bolster the perception that oil market fundamentals are continuing to improve. However, oil prices above current levels at any point in the coming months would be pouring gasoline on the fire, since this would encourage even higher levels of U.S. shale investment and production.
Nothing is ever certain in the world of oil, but a crude awakening for energy investors could be near at hand.
Which Oil Stocks are Undervalued?
Royal Dutch Shell (RDSB)
With the BG acquisition in the books, Shell is embarking on the necessary steps to compete in a world of $60-per-barrel oil. Like the rest of the integrated group, Shell is working to reduce its cost base, which has become bloated during the past five years, by reducing head count and improving its supply chain. The integration of BG is integral to Shell’s efforts, as it holds the potential for $4.5 billion of cost-reduction synergies.
Furthermore, the addition of BG’s low-cost production reduces Shell’s per-barrel operating cost, which ranked among the highest in its peer group. Shell already reduced operating cost by 20% from 2014 levels by the end of 2016, but further reductions are possible in later years.
Amec Foster Wheeler (AMFW)
Amec Foster Wheeler is among the largest global engineering and construction firms; it specializes in energy and related sectors and is the product of the November 2014 combination of London-based Amec with global E&C firm Foster Wheeler. In buying Foster Wheeler, Amec hoped to broaden its energy business by combining its upstream/exploration and production-focused business with Foster Wheeler’s midstream and downstream expertise.
AMFW’s E&C business operates in three geographically oriented segments. In 2015, it reported Americas revenue and adjusted EBIT of £2.65 billion and £161 million, respectively. North Europe and Commonwealth of Independent States revenue and EBIT were £1.5 billion and £134 million, respectively. Asia, Middle East, Africa, and Southern Europe generated revenue and EBIT of £1.05 billion and £68 million, respectively. The global power group has been targeted for divestment.
