As we all know, crude oil is a global commodity, subject to macro and geopolitical forces, as well as a host of other forces influencing the supply/demand balance. Some are short term, others more long term in nature. And markets try to discount, with varying success, as many such factors as they can.
Along with the broader market, E&Ps have recently suffered a painful slide, with the EPX index down 9.3% as of early August as compared to its level at the end of June. What triggered the sell-off? Profit-taking after a good run in general equities, of course, is a good starting point. From there, culprits might include: market complacency, sooner prospects of rising interest rates, a high-yield bond sell-off, saber rattling by Russia, a stock swoon in Germany, Argentine default, Portugal bank failure … Take your pick.
A pullback in crude has also been a major factor, reflecting a less stable macro backdrop and general weakness in commodities from a strengthening dollar. Perhaps most importantly, the geopolitical risk premium associated with the Islamic State’s insurgency in Iraq has—at least temporarily—subsided from earlier peak levels when observers speculated as to the IS forces’ ability to potentially reach the major oil fields in southern Iraq. The Gaza-Israel conflict may have likewise passed its peak.
Amid these pressing, short-term events, it is hardly surprising that little attention has been paid to what has been a remarkable move in the long end of the futures curve for Brent. As discussed in a J.P. Morgan report, over the last year there has been an $11 per barrel upward shift in the longest dated Brent futures price (the December 2021 contract), which in early August reached $98.70 per barrel (bbl)—described as an “extraordinarily large movement at the tail of the curve,” given little change in the front end over the same period.
With most of the move happening since April, J.P. Morgan’s commodity analysts believe the strength in long-term Brent futures mainly reflects “a downshift in OPEC supply expectations” given insurgencies in Iraq and Libya. In turn, this implied a “material shift in expectations” about the marginal supply cost that would be needed to clear the crude market in the future. Oil observers may recall the International Energy Agency had projected Iraq would account for about 60% of anticipated growth in OPEC capacity.
The future supply picture in Libya is similarly unpromising, according to a Morgan Stanley report that cites an increasing risk of damage to oil and gas infrastructure. The report suggested production is likely to remain at 400,000 to 500,000 bbl/d for the balance of 2014, growing only modestly to about 700,000 bbl/d in 2015. This is down from a previous forecast of 800,000 to 1 MMbbl/d for 2015, and compares to Libya’s 2012 production level of 1.4 MMbbl/d.
For West Texas Intermediate (WTI), which is less directly affected by international events, the forward Nymex curve remains at an $11 to $12/bbl discount to Brent for all but one of the years from 2016-2021. This differential could narrow if a more meaningful relaxation of crude export legislation—beyond just condensate treated in a certain stabilization process—were enacted. Scott Sheffield, Pioneer Natural Resources’ CEO, recently said he anticipated such a move no later than 2017. So, amid the sell-off in the EPX, at least there are long-term beacons indicating the potential for a robust crude market down the road.
Closer to home—and certainly more immediate—a cloud has lifted that previously had overshadowed prospects for future energy growth in Colorado. In a compromise between environmentalists and the energy industry, former geologist and current Colorado Gov. John Hickenlooper persuaded both sides to withdraw ballot initiatives—including one pushing for stricter setback rules—that augured uncertainty for energy and potential losses for Democrats pending resolution in the November 2014 elections.
The upshot was an agreement to form an 18-member task force—including not just environmental and energy interests, but also broader sections of the economy—that would work on bills addressing the oil and gas industry. Beneficiaries of the uncertainty being lifted are E&Ps levered to the Niobrara Shale, including Synergy Resources (NYSE: SYRG), Bonanza Creek Energy (NYSE: BCEI) and Bill Barrett Corp. (NYSE: BBG) Also benefiting are longstanding leaders in the play, Noble Energy (NYSE: NBL) and Anadarko Petroleum (NYSE: APC), with the latter particularly profiting from its Land Grant acreage that accounts for a good part of its mineral revenues.
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