Have Oil Prices Peaked?

Growing U.S. shale oil production poses a threat to oil prices and the outlook for indebted higher cost producers such as Pengrowth Energy Corp. (TSX:PGF)(NYSE:PGH).

Crude has rallied sharply over recent months, with the North American benchmark West Texas Intermediate (WTI) climbing to over US$55 per barrel and Brent hitting almost US$63 per barrel.  This growth has sees investors flock to the flailing energy sector as they seek to cash in on higher oil and consequently stock prices. While many pundits claim that oil will climb higher because of OPEC’s decision to renew production cuts until the end of 2018, growing supply constraints in the Middle East and diminishing U.S. shale oil production could make prices collapse once again.

Global oil supplies and in particular U.S. shale oil production is not as constrained as many pundits would have us believe, however. While oil likely won’t fall to under US$40 per barrel, any significant increase in supply could see it fall to under US$50 per barrel. 

Now what?

For some time, there have been mounting claims that U.S. shale oil production growth has peaked and that production won’t increase at the rate previously predicted. This is primarily because third quarter 2017 industry results indicated that shale oil producers were not as profitable as had been estimated due to greater-than-forecast costs leading to higher breakeven prices.

However, these predictions have proved far from accurate. U.S. oil production continues to grow, primarily driven by rising shale oil output. In September 2017 it grew by 3% month over month to almost 9.5 million barrels daily, its highest level since May 2015.

Meanwhile, the U.S. Energy Information Administration (EIA) production estimate for the first week of December 2017 came in at around 9.8 million barrels daily. This estimate was 11% higher than a year earlier and the highest level ever recorded by the EIA.

Money continues to pour into the U.S. shale oil industry because of firmer oil prices, highlighted by the rising U.S. rig count. The second week of December saw an increase of 931 active rigs from the previous week and was nearly 50% higher than the previous year.

Furthermore, the International Energy Agency (IEA) recently revised its 2018 U.S. production estimates upwards, forecasting that output would grow by 870,000 barrels daily during 2018 compared to an earlier estimate of 790,000 barrels. This would take U.S. oil production to over 10 million barrels daily.  The IEA also expects that the U.S. will be responsible for 80% of the world’s growth in oil production between 2018 and 2025, with the majority stemming from shale oil.

Such significant production growth will weigh heavily on oil, particularly the North American benchmark price or WTI. This growth will support the wide differential that currently exists between WTI and Brent, making U.S. oil exports more attractive and further stimulating investment in the shale oil industry. This would thereby place greater pressure on oil prices). 

So what?

The forecast spells bad news for Canada’s energy patch, which is only just starting to recover from the prolonged slump in crude. One stock that would be sharply impacted by crude falling to under US$50 is Pengrowth Energy Corp. (TSX:PGF)(NYSE:PGH). While the company managed to reduce its mountain of debt from an incredible $1.3 billion to $613 million over the course of 2017, it still needs WTI to reach US$50 per barrel or greater to meet its budget. Pengrowth is also heavily reliant on higher WTI to fund the ongoing development of its Lindbergh asset and further reduce debt to a more manageable level.

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

construction workers talk on the job site
Energy Stocks

Best Stock to Buy Right Now: Baytex vs Suncor?

Suncor and Baytex stocks both look like solid companies offering growth and dividends. But which is the better buy?

Read more »

bulb idea thinking
Energy Stocks

3 Incredibly Cheap Energy Stocks to Buy Now

Energy stocks are trending upwards on the back of several key factors. And these three continue to be top cheap…

Read more »

Pumpjack in Alberta Canada
Energy Stocks

Should You Buy Freehold Royalties Stock for its 8% Yield?

Freehold Royalties is a TSX dividend stock that offers shareholders a forward yield of 8%. But is the energy stock…

Read more »

Muscles Drawn On Black board
Energy Stocks

Is Suncor Energy Stock a Good Buy?

Suncor is on a roll in 2024. Are more gains on the way?

Read more »

profit rises over time
Top TSX Stocks

3 Reasons to Buy Enbridge Like There’s No Tomorrow

Have you considered buying Enbridge (TSX:ENB)? Here are 3 reasons to buy Enbridge today for lasting growth and income.

Read more »

oil pump jack under night sky
Energy Stocks

Is CNQ Stock a Buy for its 4.5% Dividend Yield?

CNQ stock is one of the best options out there for dividend growth. But what about value? Let's take a…

Read more »

Pumpjack in Alberta Canada
Energy Stocks

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

Imperial Oil stock is in a precarious position, so what should investors consider as we head nearer to 2025?

Read more »

construction workers talk on the job site
Energy Stocks

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

Suncor Energy stock is trading at its decade-high on uncertainty in the oil market. Should you buy, sell, or hold…

Read more »