Our Perspective on Those $100 Oil Forecasts

Is oil going to $100 per barrel? Wall Street’s consensus increasingly says yes, with forecasts now calling for West Texas Intermediate (WTI, the US benchmark) and Brent (global) crude oil prices to pass $100 or even $120 later this year—up from WTI’s current $88.20 and Brent’s $89.32.^[i] If those forecasts prove true, it would complete oil’s round trip to prices from before the shale boom-led glut—making it no coincidence that supply concerns underpin those projections. Virtually no analysts, as far as we have seen, see oil production coming anywhere near pre-pandemic levels, which strikes us as a case of recency bias—extrapolating what just happened far into the future. We think folks are missing some underappreciated supply drivers, yet even if we are wrong and oil jumps high from here and stays there, we doubt there will be much economic (or market) impact. Stocks and the economy did fine with oil above $100 in most of 2011 – 2014, and they can probably do so again.

The high oil case rests on production continuing to crawl in North America and OPEC+ nations. The latter made headlines today for agreeing to proceed with a planned 400,000 barrel-per-day (bpd) production increase in March. Yet as many have noted, the cartel and its partners have struggled to reach higher production targets in recent months. African producers are struggling, too. Nigeria continues to contend with terrorist attacks on its oil infrastructure, and conflict and a political void in Libya leave the country with Africa’s biggest proven reserves idling. Elsewhere, Russia is developing some new fields more slowly than expected, and Saudi Arabia—which has ample spare capacity—has declined to make up the shortfall. Hence, according to a Wall Street Journal analysis of an internal OPEC report, the cartel missed its December target by 824,000 bpd.^[ii] Add in fears of Russia cutting oil exports to the EU—whether because of sanctions or saber-rattling—and you get the specter of a big shortage.

Thing is, these headwinds aren’t really new. OPEC+ participants have long struggled to meet quotas. Yes, Russian exports to Europe are a wildcard, but the oil market is fully global. If Russia does stop supplying Europe, the market will simply shift. Perhaps that supply will go elsewhere—maybe China—while the US, North Sea, Middle East and North Africa, Canada and Brazil fill Europe’s shortfall. Oil, like water, always finds a way, and rising prices would be a strong incentive to ensure it does. Moreover, for all the attention OPEC+ receives, the cartel’s relevance has long been on the wane, largely because the US has become the world’s swing producer. High prices encouraged booming US production a decade ago. They can easily do so again.

Actually, there is plenty of evidence they already are. The oil-to-$100 crowd notes production has been slow to recover from pandemic lows, and they don’t see that changing any time soon, arguing rising breakeven prices (due to higher labor and equipment costs) and impatient shareholders are incentivizing oil producers to delay investment. To that, well, we have some questions. If breakeven oil prices are such a deterrent, then why are Canadian producers projected to boost investment by 22% this year?^[iii] Why is investment in Alberta, home to Canada’s oil sands—one of the costliest places to drill on the planet—projected to rise 24%? Why is oil production in the US’s Permian Basin now heading to all-time highs above 5 million bpd?^[iv] Why did the Bureau of Land Management approve 5,145 permits to drill on Federal and tribal land in fiscal 2021, plus another 511 in October and November?^[v] Oh, and why is that fiscal 2021 total higher than every year since 2008?^[vi] Call us crazy, but that looks more comeback than cutback.

Another thing: One of the biggest reasons US oil production recovered slowly is that oil companies opted to pay down debt as prices rose last year—a byproduct of the debt financing accrued during the shale boom and the wave of bankruptcies in the industry when oil crashed in 2015 and 2016. But now, according to the latest figures from S&P Global, US oil and gas exploration and production companies’ total net debt is down from $298 billion in 2020 to $167 billion today, a multiyear low.^[vii] Producers have taken their medicine. The industry has consolidated. While we wouldn’t expect a flood of debt-fueled investment from here, there also isn’t much indication high debt is necessary to restore high production. Oil prices now are over $20 per barrel higher than in 2018 and 2019, when production soared to all-time highs. That makes drilling a lot more profitable than it was, which should be enough to encourage more investment and production.

None of this precludes short-term spikes, especially with geopolitical tensions affecting sentiment. Yet in our view, oil’s January spike was likely markets pricing in the risk of Russian supply disruptions—similar to how stocks typically fall in the run up to regional conflict. But as time rolls on and supply and demand come more into balance, oil prices probably surprise the world by staying benign.

Even if they do breach $100, there isn’t much sign this would be so problematic. For one, a move to that Big Round Number amounts to a mere 12% rise in Brent prices from today’s levels. That isn’t an enormous spike. Oh, and during the entire stretch from 2011 to 2014 when oil was north of $100, global stocks rose 42.4% while the S&P 500 rose 65.1%.^[viii] US GDP grew—slowly, in keeping with the 2009 – 2020 expansion’s norm—but grew nonetheless. The period ended with US shale producers and OPEC oversupplying the market, leading prices to tank. Then people feared low oil prices spelled trouble for stocks and the economy and the fear cycle turned anew.

Maybe, if oil breaches $100, the story doesn’t end exactly like 2011 – 2014 this time. But we strongly doubt that and that alone would have the negative effect some seem to sweat.