null After the U.S. Shale Revolution
Manager Insights

After the U.S. Shale Revolution

Article Manager Insights Equity
September 2016
After the U.S. Shale Revolution

Authors & Contributors

The oil market recovery was called into question during September as fears of oversupply stoked volatility. It's the latest chapter in the 18-month bust precipitated by U.S. shale. Shale will continue to grab headlines, but non-U.S. production will be more important for prices.

The Landscape

Business models may change after the severity of the last cycle, but whether they do or not, the commodity framework has. U.S. shale was so disruptive it created the largest boom-bust on record. By now, most agree short-cycle shale projects will keep prices in check. The takeaway: we can make oil on demand, but we just don't need to right now.

U.S. shale was so revolutionary it caused massive supply growth, which took a long time to slow. Prices fell dramatically for a protracted period of time, and external factors like Iraq and Iran aggravated the agony. As a result, capital investment across the sector saw the deepest, most prolonged cuts of the last three decades. Shale may turn on and off quickly, but the other 96% of the oil market does not and will continue to struggle at these levels.

Capital starvation and underinvestment has created an air pocket in the global oil project pipeline. If global consumers don't cut their demand growth rates in half over the next three years, we may have a supply shortage. What happens when the inventories fade and global economies continue to expand? How severe is the damage from a continued, historic lack of investment? What parts of the supply chain will capture the most value on the rebound?

The Call

U.S. shale will remain at the forefront, but it's the tail wagging the dog. As prices improve, investment dollars (and leverage) will flow for short-cycle unconventional exploration & production (E&P) companies. Mini-cycles should keep prices below $70 per barrel in the near term, with output growth flexing between 1 to 2 million barrels per day (bpd) each year. However, the rest of the 90 million bpd market is losing more than 5 million bpd annually—U.S. supply growth will ultimately fail to satisfy global demand.

But it won't be for lack of trying. We expect U.S. E&Ps to spend and U.S. services to drill, frack, pump and recover. We believe most energy companies we follow have significant earnings upsides; the only question is how much and how fast. Given our view of moderate global demand growth with modest pricing, we currently prefer activity-levered services and are highly selective in price-sensitive asset owners like E&Ps.

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