Research: S&P raises oil and gas price assumptions

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S&P Global Ratings has raised its price assumptions for Brent crude oil for 2018. 

Our West Texas Intermediate (WTI) and Henry Hub natural gas assumptions remain unchanged for 2018 and 2019. In addition, we added price assumptions for 2020 to our price deck. We use the price deck to assess sovereign and corporate creditquality, in particular for exploration and production (E&P) companies in accordance with the ratings methodology set forth in Methodology For Crude Oil And Natural Gas Price Assumptions For Corporates And Sovereigns, published November 19, 2013. We anticipate very few rating actions resulting solely from these revised price assumptions, which are effective immediately.

Our near-term oil and natural gas price decks broadly reflect our assessment of futures prices. We recognise the typical volatility of these market indicators, as demonstrated during 2017. We also note the persistence of a wider (US$6/bbl) differential between Brent and WTI recently, although we believe this differential is likely to be nominally smaller in 2018. We base our long-term price assumptions mostly on fundamental analysis including assessments of the marginal cost of oil and gas production, as well as supply and demand fundamentals, for example.

Prices for brent and WTI

Overall, we continue to expect Brent and WTI to be range-bound in 2018. We note that Brent has been trading above US$60/bbl since October 27, 2017, having closed at that price on September 25 for the first time since July 2015. As present, futures prices remain above US$60/bbl until November 2018.

We believe the price increases reflect ongoing OPEC production cuts, supply disruptions, and temporary production declines as well as positive market sentiment about demand.

Shipments from northern Iraq were reportedly lower in October and production from several other regions was down as well. However, we assume these specific supply issues will be addressed in coming months. What's more, we believe that continuing production growth may marginally exceed consumption growth in 2018. We have maintained our WTI assumption at US$50/bbl. This largely reflects both prevailing spot and futures prices. The Brent/WTI differential has widened to more than US$6/bbl in November 2017 from a recent average of about US$2.5/bbl.

We ascribe this to the inventory build at Cushing (Oklahoma) following Hurricane Harvey, the US refinery turnaround season, US producer hedging activity, and growing US production and healthy demand for Brent crude from international refineries exhibiting strong margins. We believe that many of these factors are temporary.

Our view is that the main underlying structural reasons for WTI trading below Brent are the additional transportation costs and some capacity constraints to bring crude from inland Cushing to the US coast. In contrast, there's a much lower differential between Light Louisiana Sweet (LLS) and Brent, both of which are physically closer to global markets. We therefore see the Brent/WTI differential narrowing in the coming quarters.

OPEC cuts underpin global oil markets

The 1.8mbd of production cuts by OPEC and other countries remains key to the relative stability of oil prices. Based on recent reports, our assumption is that the majority of the cuts will remain in place for 2018.

We do see some risk that compliance could weaken by certain OPEC and non-OPEC producers during 2018, although net compliance has been broadly consistent to date.

We have seen substantial non-OPEC production growth from significant field developments in 2017 and project a continuation in 2018. However, for us net growth from the US, particularly onshore shale oil, continues to be the most important factor countering the effectiveness of the OPEC cuts.

The US Energy Information Administration points to total US crude oil production averaging 9.2mn barrels a day (mbd) for 2017, rising to 9.9mbd in 2018. US E&P companies and oil producers are focusing investment on their most productive and profitable wells. We estimate that US$50/bbl can support material shale production and growth.

This is demonstrated by the increasing rig count and increase in hedge volumes in 2017 as prices rose. Companies took advantage of the spikes in commodity prices to lock in returns and support production next year. Further supply response could begin once the drilled but uncompleted oil wells are completed and depleted.

As the high levels of crude and oil product inventories in recent years have been on a declining trend, we don't anticipate them having such a damping effect on potential upward price moves. Indeed, lower inventories in some regions could engender price spikes in the event of unscheduled supply disruptions. This leaves the impact of potential or actual ramp-ups in US shale production – in addition to any by OPEC – as the main constraining factor for prices.

Demand for crude

Demand for crude is likely to remain clearly positive – at least for the next year or so. The EIA, International Energy Agency (IEA), and others have recently indicated robust global oil demand growth in 2018 at 1.3 per cent or above. We see this supported by positive economic growth momentum in both advanced and emerging economies.

These shorter-term dynamics are in contrast to multi-decade pressures on oil demand because of environmental concerns and policies. We believe the rate of adoption of electric vehicles and the speed of the broader energy transition are critical factors in this respect.

While the rate of change is uncertain, with every year that passes they play an increasingly larger role in both demand scenarios and company strategies.

Long-term price deck

Our long-term price deck assumptions mostly reflect our view of the pronounced industry cost deflation that has taken place over the last couple of years. We also recognise that oil demand growth over the next few years is likely to remain clearly positive, albeit moderating over time.

After a decade of inflationary pressure prior to 2015, marginal production costs have declined materially, due to engineering optimisation, improved drilling efficiencies, and cost reductions, especially in higher-cost US shale formations. Drillers, forced to improvise because of the low prices, have introduced new drilling, fracking, and well completion techniques that have resulted in more permanent cost reductions.

While we've seem recent pricing pressure from oil field service companies, particularly onshore US, many operators are targeting at least flat or lower unit costs through digitisation or closer cooperation with service companies and drillers. We haven't yet seen a significant impact of lower investment since 2015 on the net global supply of oil, which has continued to grow on an annual basis, to likely rise above 97.0mbd in 2017. Nonetheless, in the medium and longer term, natural field declines and the lower level of major new field developments are likely to have a greater impact on supply.


Related criteria

Methodology For Crude Oil And Natural Gas Price Assumptions For Corporates And Sovereigns, Nov. 19, 2013

Corporate Methodology, Nov. 19, 2013

Key Credit Factors For The Oil And Gas Exploration And Production Industry, Dec. 12, 2013


The Rally In Oil Prices--Is It Sustainable? June 28, 2016 

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Research: S&P raises oil and gas price assumptions
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