Thursday, February 26, 2015

oil prices?

After falling by more than half since last June, oil prices are not likely to recover to previous highs for a long time and the energy sector may remain under pressure for an extended period, possibly years, says Shinwoo Kim, a T. Rowe Price energy analyst.

Mr. Kim says a recovery in oil prices, which declined from over $100 per barrel last summer to the mid-$40s in January—"could take longer than people think. What's clear is that we're not going back to $100 oil. I think the new range will be around $50 to $70 a barrel."

One factor that may prolong the recovery is the surge in U.S. shale oil production from horizontal drilling and hydraulic fracturing, or fracking, as well as the slowdown in global economic growth, particularly in China.

"The productivity in U.S. production has really been surprising people massively on the upside," Mr. Kim says. "The U.S. has become the swing producer in global oil, more so than Saudi Arabia, which gave up that role when it decided not to cut production and to leave it up to the market to work it out.

"The Saudi decision was really the catalyst for lower oil prices," he adds. "It accelerated the oil price deflation, which was already in the works and would have happened over time."

Mr. Kim notes that U.S. oil production, after a multi-decade period of decline, has boomed in recent years to about 12 million barrels per day now, placing it among the world's largest oil producers, along with Saudi Arabia and Russia.

"Now, the problem is the U.S. will also respond to lower prices, so we won't grow at the same rate that we have, and that will be part of the natural correction mechanism. But I think the productivity gains that are still fairly early on in the U.S. will continue, and so oil prices will sort of be capped in the near term."

While cheaper oil prices have benefited the overall economy, they have posed a huge challenge for energy stocks, particularly oil and gas exploration and production (E&P) companies. The overall energy sector in the S&P 500 Index plunged about 18% over the second half of 2014 and almost 5% in January 2015.

Mr. Kim says it could take years before the sector fully recovers. "Some expect a sort of V-shaped recovery into the second half of this year," he says. "I think it will take much longer because we have a supply problem with oil, not just a demand problem. If it was just demand, we've seen cycles where the recoveries have been very quick. Oversupply takes much longer to fix."

As a result, Mr. Kim expects earnings of energy companies to be even worse than analysts have forecast. "Because it's a supply problem, I expect to see multiple levels of cuts," he says. "The service companies will probably get hit a little harder than the E&P companies, but I think we're just seeing the start of earnings revisions. I don't think we're done yet."

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