Is a New Oil Price War About to Emerge?

Growing U.S. shale oil production could trigger another oil slump, damaging the prospects of Pengrowth Energy Corp. (TSX:PGF)(NYSE:PGH).

| More on:
The Motley Fool

Crude has once again plummeted below the US$50-per-barrel barrier, and there are signs that a new price war is on the horizon. This certainly doesn’t bode well for energy stocks for the foreseeable future. 

Now what?

The key reason for the recent price crash was a significantly larger than expected inventory build in what are already swollen global oil stock piles. U.S. oil inventories alone grew by 8.2 million barrels during the first week of March 2017 — the single largest increase since 1982.

Even a recent surprise draw from U.S. oil stocks has failed to lift the price above US$50 per barrel.

There are signs that U.S. oil production will continue to grow.

Since West Texas intermediate (WTI) reached $50, there has been a significant uptick in activity in the U.S. energy patch. The tempo of drilling activity intensified as beaten-down operators moved quickly to boost output to take advantage of higher prices.

This is evidenced by the growing onshore rig count which, for the second week of March, grew by nine and a massive 293 compared to a year earlier.

The level of activity will only keep rising.

The oil slump was a blessing in disguise for the shale oil industry. It forced companies to reappraise their operations and trim the fat so as to make them as lean as possible to survive the protracted downturn.

Now, many U.S. shale oil companies have cut costs to the point where they are free cash flow positive with WTI around US$50 per barrel. One of the largest independent players, Continental Resources Inc. (NYSE:CLR), has slashed expenses to the point where it has forecast 2017 operating expenses of less than US$30 per barrel. This allowed it to double its 2017 capital spending so as to fund the drilling of 178 wells, which should give oil production a 29% boost by the end of 2017.

Other major U.S. oil producers are in a similar position, creating considerable impetus for them to ramp up drilling and production, even with WTI at less than US$50 per barrel.

The incentives don’t stop there.

President Trump’s ambition to make the U.S. energy independent by reducing taxes and industry regulations will add further impetus to the plans of oil companies to ramp up activity.

If U.S. oil production keeps growing, it will reduce OPEC’s incentive to maintain production cuts.

You see, OPEC and key non-OPEC oil-producing states agreed to slash output by 1.8 million barrels daily in an effort to boost prices because of growing fiscal pressures which, in many cases, were responsible for fomenting economic and social unrest.

If the U.S. shale industry steps in and fills the gap, causing prices to weaken yet again, those participants will be forced to increase output to generate greater oil revenues to fill the shortfall in government income. Saudi Arabia has already eased its own cuts, causing February 2017 oil production to expand by 263,000 barrels daily.

This rational could explain why the OPEC secretary general has stated that it is too early to tell whether the agreement will remain in place or not after the OPEC May 2017 meeting.

So what?

Another oil slump would hit Canada’s energy patch hard, especially heavily indebted operators, such as Pengrowth Energy Corp. (TSX:PGF)(NYSE:PGH), which have banked on crude rising to US$55 per barrel. This would force them to wind back capital spending, causing production, and hence cash flow, to fall.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

More on Energy Stocks

man touches brain to show a good idea
Energy Stocks

1 No-Brainer Energy Stock to Buy With $500 Right Now

Should you buy a cyclical energy stock at its decade-high? Probably not. But read this before you make a decision.

Read more »

A solar cell panel generates power in a country mountain landscape.
Energy Stocks

Top Canadian Renewable Energy Stocks to Buy Now

Here are two top renewable energy stocks long-term investors can put in their portfolios and forget about for a decade…

Read more »

oil and gas pipeline
Energy Stocks

Where Will Enbridge Stock Be in 3 Years?

After 29 straight years of increasing its dividend and a current yield of 6%, here's why Enbridge is one of…

Read more »

Pumpjack in Alberta Canada
Energy Stocks

Is Enbridge Stock a Buy, Sell, or Hold for 2025?

Enbridge stock just hit a multi-year high.

Read more »

oil pump jack under night sky
Energy Stocks

Where Will CNQ Stock Be in 3 Years?

Here’s why CNQ stock could continue to outperform the broader market by a huge margin over the next three years.

Read more »

engineer at wind farm
Energy Stocks

Invest $20,000 in This Dividend Stock for $100 in Monthly Passive Income

This dividend stock has it all – a strong outlook, monthly income, and even more to consider buying today.

Read more »

A worker overlooks an oil refinery plant.
Energy Stocks

Is Imperial Oil Stock a Buy, Sell, or Hold for 2025?

Valued at a market cap of $55 billion, Imperial Oil pays shareholders a growing dividend yield of 2.4%. Is the…

Read more »

Pumpjack in Alberta Canada
Energy Stocks

Where Will Imperial Oil Stock Be in 1 Year?

Imperial Oil is a TSX energy stock that has delivered market-thumping returns to shareholders over the last two decades.

Read more »