Goldman Sachs on OPEC cuts, US shale boom, and 2018-19 forecast upside
OPEC's November decision to cut production was rational, but it boost the US credit market helping speed up the US shale machine
A Goldman Sachs’ report this week sheds light on OPEC’s changing role, and how the November production cut has helped create the US shale revival.
2017 to 2019 is likely to see the “largest increase in mega projects production in history,” led by US shales, according to Goldman Sachs’ Top Projects database.
Analysts see possible upside to their forecasts for 2018-19. If private producers are as efficient as companies covered in the database, the upside could be “substantial.”
OPEC’s changing role
OPEC has changed from long-term price setter to inventory manager. Short time to peak production for shale projects (6-9 months vs 7 plus years in the past) has diminished OPEC’s role in controlling prices.
OPEC’s decision last November to cut production was rational, fitting into their role as inventory manager. The move, however, also led to an unintended consequence, as a bullish credit market coupled with the delayed delivery of a capex boom from 2011 to 2013, and has laid the ground work for record non-OPEC production growth in 2018.
Reasons for faster than expected re-start of US E&P shale projects
The OPEC decision led to a period of rare stability, after three volatile years, boosting the US credit market as well as industry confidence that OPEC provided a floor for oil prices. This has led to a strong re-rating of the US energy credit market, which is up to 76%.
The high yield market is a key driver due to several reasons:
- Lower cost of debt;
- the concurrent rise of horizontal drilling and fracking techniques;
- and the short-cycle nature of shale, accompanied by the development of a commodity hedging market, which has increased tolerance for E&P leverage for management and investors.
However, Goldman Sachs notes that:
“While we can argue that factors 2 and 3 are fundamental in nature, we believe artificially low treasury rates have contributed to the overfunding of the E&P space. In our view, this has amplified the “boom” and “bust” nature of the industry in recent years. In response, we believe OPEC is now essentially providing artificial stability to crude markets.”
There could be overconfidence in the oil industry stemming from the OPEC decision
Industry is using a wide spread of oil price assumptions ranging from Russia at US$46/bl, to the European Integrateds at US$60/bl. This is despite a completely flat forward curve at around US$52/bl.