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Q1 2023 Research Theme: Reasons to be Bullish

To paraphrase Ian Dury & The Blockheads’ 1977 punk hit ‘Reasons to be Cheerful, Pt. 3’, there are a host of reasons to be bullish about global oil pricing and thus the future revenues and cashflow of the upstream and oilfield service sectors – underpinning the long-held strategic rationale and investment focus of the PillarFour Capital team. In this research piece we analyse five key macro datapoints that have the potential to drive oil prices in the back half of 2023 and beyond.

1. Global Supply Growth is Lagging Demand

Global oil demand is forecast to surge in the latter half of 2023, predominantly driven by a resurgent Chinese economy and buoyant international travel.

Global Commercial Flights: Up 30% Year-on-Year, Above Pre-Covid Levels

Source: Flight Radar 24

Amid such resurgent oil demand, the voluntary supply cuts recently announced by Saudi Arabia and other OPEC+ Middle East producers will, if adhered to, reduce OPEC+ supply by some 1.2 mmbopd from May. Russia also announced a 0.5 mmbopd production cut as of March, however its March oil exports conversely rose by 0.6 mmbopd sequentially to their highest level since April 2020. Whether any such production cuts occurred, at current levels the risk to future Russian oil export volumes arguably lies to the downside. OPEC and the IEA each forecast record global oil demand of 101.9 mmbopd for 2023, up by 2 mmbopd y-o-y.

Amid Surging Global Oil Demand, OPEC+ Cuts Promise 2H23 Supply Deficit

Source: IEA, April 2023

Although non-OPEC producers, led by the US and Brazil, are forecast to grow production by 1.9 mmbopd y-o-y, these OPEC+ cuts will limit annual global supply growth to 1.2 mmbopd for 2023, less should Russia’s oil exports indeed prove difficult to maintain.

Global supply growth will thus lag that of global demand, the result being a material global oil supply/demand imbalance of some 2 mmbopd from mid-year and in turn as much as a 350 mmbbl draw on global oil & product inventories by year-end.

2. Global Inventories Will Hit 10-Year Low In Event Of Sustained 2H23 Market Imbalance

While reduced demand across the developed OECD due to warm weather and sluggish industrial activity modestly lifted global oil inventories year-to-date, such inventories still remain below average pre-Covid levels. Any material 2H23 supply deficit and allied draw of up to 350 mmbbls – as laid out above – will see global inventories hit 10-year lows.

Global Oil Inventories (onshore & on water) Modestly Below The Pre-Covid Average …

Source: Kpler, Energy Aspects

But US crude oil and oil product inventories are already at a multi-year low, lying almost 400 mmbbls or 25% below 5-year pre-Covid seasonal average levels.

… But US Crude Oil, Gasoline & Distillate Inventories Are Already At Multi-Year Low

Source: EIA

3. OPEC Is Back In The Driving Seat And Needs Higher Oil Prices

The recent OPEC+ production cuts may have surprised the market, but they were perfectly rational given OPEC members’ desire for higher pricing amid buoyant oil demand growth, and the limited near-term supply-side response expected from US shale producers and the US SPR crude oil inventory, the latter being at a 40-year low.

OPEC+ is clearly back in the driving seat. Enhanced pricing power and a need for increased revenues will provide fundamental support for higher oil pricing.

OPEC Crude Oil Production: Up ~12% (3.2mm Barrels Per Day) From 2020 Production Levels

Source OPEC, May 2023

4. US Shale Is No Longer A ‘Swing Producer’

While the EIA forecasts US oil production will rise by 5% in 2023 to a new record of 12.4 mmbopd, a word of caution from the CEO of Pioneer Natural Resources: “The aggressive growth era of US shale is over … [US shale] definitely is no longer a swing producer”.

The scale and pace of growth of US shale oil production, historically the most price-elastic and prolific source of oil production, is now hindered by several issues: investors demanding returns over growth, higher costs, labour shortages and residual supply-chain issues and, most notably, new shale wells becoming less productive – even, if recent research proves correct, within the dominant Permian Basin.

US Shale Oil Production Nears Pre-Covid Levels But Pace Of Growth Is Modest

Source: US EIA

5. Global Exploration Suffers From Chronic Long-Term Underinvestment …

Over the past decade, in all but a few basins worldwide, exploration has been largely starved of capital, the result being a collapse in discovered oil resources, a dearth of development projects and, in turn the potential for future supply shortfalls.

For the oil majors, the Energy Transition has certainly played a role in diverting recent investment away from upstream exploration into alternative renewable projects.

Post Russia’s invasion of Ukraine, energy security – i.e. secure access to vital fossil fuels – now provides a powerful strategic counterpoint to energy transition-related investment. Inevitably, however, upstream exploration will increasingly compete for funding given the oil majors’ declared carbon and methane intensity reduction goals.

Source: Rystad Energy

Prime examples of such underinvestment in exploration can be found in the shrinking reserve-to-production ratios of the oil majors since 2000.

… Has Led To Diminishing Oil Reserve/Production Ratios For Oil Majors

Source: Company filings, Goehring & Rozencwajg Research

In conclusion, with buoyant oil demand growth, structural impediments to both short-cycle and longer-cycle non-OPEC supply growth and global oil inventories either at or heading for multi-year lows, the odds of a multi-year bull market for oil are favorable.

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