How Will Commodity Prices Move If The US Continues To Expand Its Oil Production?

The year 2018 has been great so far for commodity prices. Since the extension of the production cuts by the Organization of Petroleum Exporting Countries (OPEC) and its allied Non-OPEC nations such as Russia, Brent crude oil prices have gone up almost 10% and are currently trading close to $70 per barrel. This indicates the investor optimism about a further improvement in oil and gas prices through the year. While the OPEC members believe that they have factored in a surge in US oil supply due to improving prices, we believe that the growing US production will continue to pose a threat to this recovery in commodity prices. Below, we present our forecast for oil and gas prices over the next couple of years and how a surge in US oil output could impact these prices.

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The oversupply of oil and gas in the global market, particularly in the US, was a key reason behind the commodity downturn that began in mid-2014. After having suffered due to the sluggish prices, the OPEC decided to cut back its oil supply in November 2016, with a hope to see a draw-down in the US oil inventories. Interestingly, since the announcement of OPEC supply cuts, the US oil inventories have dropped by roughly 7.5% to 1,883 million barrels, in line with the OPEC’s expectations. At the current level of inventories, it will take some time for the US shale producers to flood the markets and create a similar oil glut in the coming quarters.

That said, the recovery in oil prices over the last year has allowed the US shale producers to reinstate their shale oil production, which had become non-profitable due to extremely low oil prices. Consequently, the US oil output has grown sharply from 8.69 million bpd in November 2016, to almost 9.78 million bpd at the end of 2017, representing a jump of more than 12% over the last year. With the extension of the OPEC production cuts until the end of this year, the market anticipates a further rise in the US output in the coming months. In fact, the US Energy Information Administration (EIA) expects the US output to grow at almost 11% in 2018, and estimates the country to surpass Saudi Arabia and Russia in oil production by 2019.

Although a surge in the US oil production cannot be ruled out, we believe that the US shale producers have learned their lessons from the ongoing commodity slump and have become more conservative over the last three years. Rather than flooding the markets with their shale output and causing the oil prices to decline, they are likely to plan their output expansion judiciously, conserving much of their cash flows for capital investments in the future years. Thus, we expect to see a steady yet moderate growth in the US output over the coming months. Accordingly, we forecast Brent oil prices to average at around $65 per barrel in 2018 and gradually increase to $77 per barrel by 2021 (grey bars). Further, we estimate natural gas prices to stand at $3.35 per Mcf in the current year and steadily improve to almost $4 per Mcf by 2021.

However, if the US shale producers do not operate rationally and expand their output aggressively over the next couple of years, we anticipate a slower recovery in oil and gas prices in the coming years. We present this scenario as blue bars, where the US oil output is likely to surge at a much faster rate than predicted in our base case. Under this scenario, we expect Brent oil prices to average at around $60 per barrel for 2018 and gradually rise to only $66 per barrel by 2021. As a result, we forecast gas prices to average at $3 per Mcf in 2018 and slowly grow to $3.40 per Mcf by 2021.

Feel free to create our own forecast for oil and gas prices by altering the US oil supply using our interactive platform.

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