S&P Director of Analytics: Energy Sector Balanced on a Knife Edge

From the prolific shales of the Permian to the prevailing peace within OPEC, the global oil industry seems to have come to a place of balance after years of severe boom and bust.

But Chris Midgley, global director of analytics at S&P Global Platts, cautioned that “the industry is on a knife edge. OPEC has far less spare capacity than ever, and U.S. shale producers are only cash-flow positive on half-cycle economics.”

He was the keynote speaker at the annual S&P Global Energy Outlook Forum December 7 in New York. While oil and gas were the centerpieces of the event, the agenda was comprehensive, with presentations on nuclear, renewable energy, and utilities as well.

“All of the energy sources are going to play important roles over at least the next 20 years: oil, gas, renewables, even coal,” said Midgley. Some of that big picture seems to have been missed lately with “the focus just on electric vehicles [EV] and OPEC’s efforts to rebalance the global markets.”

While acknowledging that “the EV story is a long-term story,” Midgley noted that only about a million electric vehicles will be sold this year, in contrast to 80 million conventional vehicles.

That equates to a reduced crude demand of only 30,000 barrels a day.

“The world is going to get to 100 million barrels a day of demand even with electric vehicles and greater efficiency.”

The rare sustained consensus limiting supplies from OPEC has been deserving of the attention it has gotten, Midgley indicated, but he stressed how precarious it is.

“OPEC are playing a tight balance. The objective seems to be keeping oil prices as high as possible while sustaining demand.”

The contrast would be keeping prices as low as possible while still sustaining production. The choice between the two recapitulates Midgley’s assertion that demand is expected to continue growing. Thus keeping prices low to stimulate demand is not the current mandate.

Notably, Midgley believes that OPEC has come to accept North America shale as a viable long-term global source.

“I don’t buy that OPEC was trying to crush U.S. production,” he stated. “There was over-investment at $100 a barrel.”

And while those days now seem a distant memory, Midgley suggested there is further rationalization possible shale.

“There was great responsiveness [when prices tumbled],” he said. “CEOs are now focused on cash flow and return on investment rather than just production. But shale as an industry has underperformed the S&P 500 over recent years.”

Be that as it may, there is clearly no shortage of capital flowing into the sector.

“At $50 to $60 a barrel this is a great business,” said Mark Florian, head of energy and power infrastructure funds at the major private-equity house BlackRock. “The question remains, what if we go [back] to $40 a barrel? People are stepping back to this market, yet they are cognizant of downside risk.”

Nazar Massouh, CEO of private lending firm Orion Energy Partners suggested that the severe down cycle has had a cleansing effect.

“There is no question that there have been losers. That is healthy for the industry as a whole. When we look at companies and balance sheets and there is no real different within the sector company to company, that not healthy.”

Even as producers come to terms with the “lower for longer” mindset for oil prices, it has been suggested that lately some bad old habits have been creeping back. For example, investors chasing yield are willing to go light on covenants for borrowers. Massouh indicated he had heard of such situations but noted, “overall equity levels are higher today than at the last down turn. Borrowers are better able to survive price shocks.”

Even as investors and producers refine their balancing act, unknowns remain. Noting the recent explosion and fire in a pipeline in Bahrain that country ascribed to sabotage, Midgley said that “every three years on average there is a spike in supply disruptions.” There may also be increases in non-OPEC supply. Midgley suggested that as much as an additional million barrels a day could come out of North American shale just at organic levels of growth.