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Oil Prices: Up or Down, These Three Variables Are the Ones You Need to Watch

An exclusive interview with John England, Vice Chairman, US Energy & Resources Leader for Deloitte LLP

When it comes to forecasting price movements, few commodities receive scrutiny like oil and gas. Almost every day, we turn on Bloomberg or CNBC and see top bankers give brief interpretations of their multivariate analysis for why oil prices are headed up or down. For most, this is a sufficient explanation, however, for those of you who share my degree of curiosity, a closer look is necessary. We must turn to the raw numbers and commentary offered by government regulators, third-party data providers, economists, geologists and even foreign policy experts. After all, such prognostications underpin business decisions for countless millions, from day traders to airline companies looking to hedge the cost of jet fuel. Who among them want a 30-second commercial versus a deeper understanding of a complex market?

A few days ago (April 20), Mergermarket hosted the ninth annual Energy Forum in Houston, where experts provided in-depth perspectives on price forecasting, investment trends and M&A dealmaking.

I recently managed to catchup with the conference's keynote presenter, John England, Vice Chairman, US Energy & Resources Leader for Deloitte LLP. The most pressing issue on my mind was not a price forecast, but rather what price factors were John and his colleagues at Deloitte most focused on over the next 12 – 18 months.

"The first one, obviously, is that you have to look at what OPEC is doing," he said. "We've been fairly pleased with the fact that they've been abiding by the cuts they announced late last year. I think there is some optimism that [OPEC] is going to extend those cuts through the end of the calendar year."

The 13-members of OPEC committed last year to cut about 1.2 million bbl per day in a bid to bring a vast global oversupply of crude back in line with demand and raise petroleum prices. The International Energy Agency said in a monthly report (April 13) that world stockpiles should soon start to decline. OPEC officials said in a report a day earlier that inventories shrank in developed nations during the first quarter. In downstream news, this week the financial press reported that gasoline inventories dropped an eighth week, the longest stretch of declines in three years. Stockpiles of distillate fuel, a category that includes diesel and heating oil, fell a ninth week to the lowest since November. It was the longest stretch of pullbacks in distillate supplies since 2010.

Taking bullish cues from such data, hedge funds boosted their clients' capital allocation to West Texas Intermediate futures extrapolating that oil prices will move higher. However, like trying to forecast the price of any good, it might not be that simple.

"The other thing that we are watching is how quickly US production ramps back up," John cautioned. "We’re seeing production accelerate, probably faster than we had expected." 

The US Energy Information Administration (EIA) reported recently that output from US shale fields is set to rise by 124,000 bbl in May, the largest increase in two years. The EIA forecasts that US output will rise to a record high of 9.9 million bbl per day next year. This is mostly attributable to a leaner and more cost-competitive deepwater industry emerging from the 2014/16 commodities bust, with the most attractive projects now competing with US tight oil plays. According to the authors of a Wood Mackenzie report, they estimate that on average global deepwater project costs have fallen just over 20% since 2014. Assuming a 15% internal rate of return hurdle (NPV15), 5 billion barrels of pre-sanction deepwater reserves now breakeven at USD 50/boe or lower. 

The topic of efficiency and cost cutting sustainability over the near term was a common theme among energy professionals as I researched content for this year's event.

"The demand picture is really interesting right now due to significantly positive signs. Europe is starting to see GDP growth and even in the emerging economies. For example, India has some strength that can add to the demand picture," John said.

Just as growing US production may offset OPEC cuts, technologies designed to increase output may offset innovation in fuel efficiencies and alternative sources of energy.

"In more established economies like the US, we are seeing a lot of demand reduction because of fuel efficiencies and we expect that trend to continue," John said. "A lot of the same great technology that’s been applied to the oilfield sector to reduce cost is also being applied to energy management and reducing demand."

As soon as John alluded to fuel efficiency technologies, I thought of autonomous vehicles, which have served as a talking point across M&A. Many will picture Elon Musk's Tesla and unicorn Uber, two companies aiming to lower car ownership and increase car utilization - no doubt affecting oil demand in addition to infrastructure assets and other investments. Consider this: earlier this month, Tesla (albeit briefly) became the most valuable car company in the US, overtaking both Ford and General Motors. In 2016, Tesla made 80,000 cars. General Motors made 10 million. Along those lines, close to 2,500 hydrogen fuel cell vehicles were sold or leased globally, representing a more than three-fold increase compared to 2015, according to a report published by Information Trends. GLC F-Cell, to be rolled out in the second half of 2017, ushers an era in which vehicles will be equipped with both fuel cells and plug-in propulsion batteries.

Of course, there is also renewable energy. It provided a record 55% of power generating capacity worldwide in 2016, according to a new UN Environment Programme. Solar and wind's falling cost of capital will ensure such energy sources have staying power in today's economy.

Another factor that plays a large role in oil prices is the US Dollar, which holds an inverse relationship to the commodity. It's a reason that I believe does not get enough press, especially in light of the Federal Reserve increasing interest rates and plans to unload a healthy portion of its balance sheet that include bonds with long term maturities sometime later this year or next.

However, let's leave it there for now. 

For more information regarding Mergermarket's ninth annual Energy Forum you can visit our events webpage here.

Matt O'Brien Content Editor Mergermarket Group

Follow Matt on Twitter @MattobrienMM or connect with him on LinkedIn.

Matt O'Brien is content editor for Remark, the sponsored events and publications division of Mergermarket Group, overseeing the research and editorial input for events. Matt works with the editors and reporters of Mergermarket Group's various publications to ensure the company delivers industry leading conferences. He has spent nearly 13 years in the news and finance industries. Matt has a political science and international studies BA from Rutgers University.

Matt O'Brien Content Editor Mergermarket Group

Follow Matt on Twitter @MattobrienMM or connect with him on LinkedIn.

Matt O'Brien is content editor for Remark, the sponsored events and publications division of Mergermarket Group, overseeing the research and editorial input for events. Matt works with the editors and reporters of Mergermarket Group's various publications to ensure the company delivers industry leading conferences. He has spent nearly 13 years in the news and finance industries. Matt has a political science and international studies BA from Rutgers University.

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