Cost of Shale to Drive Oil Prices Higher

After last year’s oil-price rebound, many investors wonder whether the recovery is over. Probably not. As global demand increasingly relies on US shale, we think oil prices could touch $80 by the end of the decade.

WILD RIDE SINCE MID-2014

It’s been a rocky few years since June 2014, when the price of Brent Crude oil stood at $115 per barrel. Over the next 18 months, oil fell to a trough of $32 in January 2016 before recovering to trade at more than $55 this month—about 72% higher than year-ago lows.

Many analysts think that oil can’t get much higher than $60‒$65 a barrel in the next three years. Our research suggests that these projections underestimate the costs of producing oil in order to meet demand growth.

STRONG DEMAND, FADING NON-US, NON-OPEC SUPPLY

Over the past four years or so, global demand for crude oil has increased by roughly 1%‒2% per year, peaking at 2.4% growth in 2015. Projecting through 2020, we see a steady 1% annual rise in demand.

On the supply side, members of the Organization of the Petroleum Exporting Countries (OPEC) have until now met much of the annual increase in demand. Production of non-OPEC, non-US oil-producing countries has declined, while US production has started to recover recently from a decline over the past two years.

Looking ahead, we expect OPEC production to rise modestly from 2018‒2021. Non-OPEC, non-US oil volume should decline slightly and US oil production should grow more substantially (Display).

Within OPEC, Iranian oil has already come back online post-embargo and there’s little scope for major investments needed to grow capacity. Saudi Arabia has used up its spare capacity in its effort to drive down global oil prices and make it less economical for US firms to develop shale reserves. And other oil producers, including Venezuela, Nigeria and Libya, have their own production challenges.

Outside OPEC, non-US oil producers will struggle to generate more supply. With oil below $50 a barrel until recently, investments in new oil reserves just weren’t profitable. Since new exploration and production (E&P) takes a few years to bring online, that lack of investment could suppress oil supply levels for years. In other words, the impact of low oil prices in 2014‒2016 could be felt for years through decreased supply.

Against this backdrop, US oil production will be essential to meet steadily growing global demand for oil, in our view. This means that in the coming years, oil prices will be increasingly determined by the costs of extracting that oil from various US shale deposits.