A Shift in the OPEC Playbook: 2014 vs. 2017
Unlike 2014 and 2015, we do not believe crude oil prices are remaining low as a result of OPEC (Organization of Petroleum Exporting Countries) threatening to increase production. Rather, we believe it is resulting from the U.S. producing more every month, as U.S. producers are able to do so at price levels below $50 per barrel.
Despite global crude oil supply and demand levels returning to the current state of equilibrium1, OPEC has agreed to a large and extended production cut because they need higher prices. While the collapse of crude oil prices has tested energy companies around the world, it has confirmed U.S. producers have a greater ability to reduce costs and increase efficiency, relative to global competitors. Although the potential benefits to U.S. energy companies are fairly clear, not all segments of the energy value chain will benefit equally.
- After two years of deep crude oil price declines, the strategy from OPEC has shifted from producing at maximum capacity, with little regard for the impact on global supply or crude oil prices in 2014, to announcing an agreement in 2016 to limit production, in an attempt to reduce global storage inventories and ultimately increase crude oil prices. This shift is indicative of the “role reversal” that has taken place in the global energy landscape over the past few years, as the U.S. became the marginal producer of crude oil, in an effort to bring global supply and demand back to equilibrium.
- Following a brief period of decline, U.S. production growth ultimately resumed, as efficiency gains and operational improvements reduced the average U.S. shale break-even cost from over $60 per barrel in 2014 to approximately $35 per barrel today2, allowing U.S. producers to grow crude oil production at $45-50 per barrel. Today, U.S. crude oil production is at a higher level than it was in 2014, when crude oil prices were more than twice the current levels, while OPEC members struggle to drive crude oil prices higher.
- Of the 19.5 million barrels per day consumed on average in the U.S., approximately 10 million of those barrels are imported (with over three million of those barrels currently sourced from OPEC producers). As U.S. crude oil production growth has resumed, the opportunity to replace imported barrels with domestic production exists once again. Producers of crude oil may benefit from increased production volume, but at relatively lower margins resulting from low crude oil prices.
- Midstream MLPs would likely have a more direct benefit from increased domestic production, as the producer customers pay a fee to the owners and operators of the pipelines for each barrel they send through, and that fee is not derived from the price of crude oil. As a result, midstream MLPs are able to benefit from increased fee-based volumes through pipelines without lower margins from lower crude oil prices.
As a result of the agreement from OPEC producers to cut and cap supply for a total of 15 months, in conjunction with non-U.S., non-OPEC production in a state of structural decline, global crude oil inventory levels are falling3. Similarly, crude oil supply and demand have returned to equilibrium, and may very likely already be in a significant state of global undersupply.
Meanwhile, U.S. producers are currently growing production and potentially stealing market share from OPEC, as incremental U.S. production replaces imported barrels. The U.S. currently produces less than 50% of the U.S. oil demand, implying a considerable amount of market share to be won. The increasing production in the U.S. has the potential to lead to additional pipeline volumes, increased demand for new pipeline capacity, and consequently, increased cash flows and distribution growth for the MLP sector.
1. Source: International Energy Agency, “Oil Market Report,” November 2014.
2. Source: “Break-even Pricing,” Rystad Energy and Reuters Graphics, January 2017.
3. Source: International Energy Agency, “Oil Market Report,” March 2017.
This information is provided as a resource for information only. Neither New York Life Insurance Company, New York Life Investment Management LLC, their affiliates, nor their representatives provide legal, tax, or accounting advice. You are urged to consult your own legal and tax advisors for advice before implementing any plan.
The opinions expressed are those of Cushing® Asset Management, LP as of the date of this report and are subject to change. There is no guarantee that any forecast made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment.
All investments are subject to market risk, including possible loss of principal.
MLPs and other natural resources sector companies are subject to certain risks, including, but not limited to, fluctuations in the prices of commodities; the highly cyclical nature of the natural resources sector may adversely affect the earnings or operating cash flows of the issuers; and a significant decrease in the production of energy commodities would reduce the revenue, operating income, and operating cash flows of MLPs and other natural resources sector companies and, therefore, their ability to make distributions or pay dividends.
Midstream MLPs gather, process, and transport natural resources.
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