When it comes to investing in the oil and gas industry, there are a lot of things that can prevent people from making sound investment choices. There is so much noise around oil prices and where they are going at that instant, it can make people ignore the longer-term trends on which investors should really be focusing.
Perhaps one of the more valuable sources of information about the longer-term trends in the oil market is Schlumberger‘s (NYSE: SLB) management conference call. In it, CEO Pall Kibsgaard’s market outlook cuts through a lot of the day-to-day noise that we see so often in the daily headlines. Here are three key points he made on the company’s most recent conference call that challenge the narrative we see in most financial publications today.
Inventory reporting isn’t that helpful
Pick up the business section of any newspaper, or look at an online article that’s discussing oil prices. Chances are, the explanation for a lot of oil’s price moves will be because of inventory levels in the U.S. Reports like this are likely to influence one’s investment decisions. If you ask Kibsgaard, though, those reports aren’t an accurate representation of the oil market as a whole. According to Kibsgaard:
The key indicator for this evolving trend continues to be global oil inventory levels, not U.S. inventories alone. Significant weekly swings in import and export levels often mars the actual evolution of the underlying U.S. supply and demand.
So, if U.S. inventory data isn’t that valuable for investors, why is so much attention given to it? Aside from short-term traders that are likely going to make knee-jerk moves based on these data, they are more or less the most reliable data of the oil market at any given moment. Few other countries report inventory level data as frequently and as completely as the U.S., and some other countries may not report these things as accurately as we would like. This makes getting a feel for global inventories difficult to report. So, in absence of better data, this is what we get.
Fortunately for longer-term investors, there are few companies as plugged into the global oil market as Schlumberger. Here’s what the company thought of current inventory levels, according to Kibsgaard:
Global crude stocks and days forward coverage is already well below the five-year average, and bigger growth is expected from the current stock levels in the coming quarters. These anticipated stock draws are underpinned by a continued strong outlook for oil demand with global growth continuing to be projected between 1.5 million and 1.8 million per day in both 2018 and 2019.
This information is nowhere near as granular or as frequent as U.S. inventory level data. For an investor looking at this industry, though, it is a much more valuable data point.
Despite OPEC’s efforts, the market is getting tight
Whenever OPEC makes a decision about its output or what it foresees in the market, it gets a lot of attention. So, of course, the recent news that the largest contributors to OPEC as well as Russia are looking to expand their output has some people projecting that oil prices will decline. That, coupled with U.S. shale drilling’s ability to quickly react to high oil prices, suggests that this period of $70-per-barrel oil is going to be short-lived.
According to Schlumberger, though, these headlines are a bit overblown. Here’s why Kibsgaard thinks these two factors aren’t the great oil price influencers many consider them to be:
At present, the collective spare capacity of the three core OPEC countries is only in the range of 3 million barrels per day. There are also emerging questions around whether the very bullish production growth outlook for U.S. shale oil can be fully met. The industry is starting to face challenges linked to well to well interference as more infield drilling takes shape. Lower production per well as drilling increasingly steps out from tier one acreage.
Just for a little context here, 3 million barrels per day of spare capacity sounds like a big number, and historically, that much spare capacity was considered a lot. However, oil demand has increased over the years, and 3 million barrels per day represents around 3% of total capacity. That, historically, is the low end of global capacity as a share of overall production.
The other thing worth understanding here is tier one acreage. This is basically all of the sweet spots in shale basins across the U.S. that have the best returns. They are relatively cheap to drill, and the production rates are robust. A lot of shale’s resiliency in lower price environments has been drillers tapping these sweet spots. As producers have to start drilling wells in tier two acreage, it will be more expensive, and producers may not be able to grow production as quickly.
I don’t doubt that headlines about OPEC increasing output will have an impact on oil prices. Based on Kibsgaard’s assessment, though, that impact may be short-lived.
The current wave of spending may not be enough
As oil prices have grown, so too have the capital spending budgets of exploration and production companies. Higher spending means more outupt, but as Kibsgaard had previously noted, the returns on that spending may diminish as companies exhaust their best drilling locations. So, despite these upticks, Schlumberger is anticipating that the wave of capital spending is just getting started:
In spite of these clear signs of a tightening oil market, there has been no upwards revision to 2018 E&P spending, with North America and international upstream investment still expected to grow in the range of 20% and 5%, respectively.
Based on these investment levels and the current supply, we believe it is increasingly likely that the industry will face growing supply challenges over the coming years and that a significant increase in global E&P investment will be required to minimize the impending production deficit.
For investors who have been following the oil market for a while, or have looked at the history of the industry, one thing that pops out is that the market perpetually goes through phases of over or underinvestment. The past two years have been periods of historically low investment. Total oil discoveries in 2016 and 2017 were 14.7 billion barrels, but consumption today is around 35 billion barrels annually. We have a lot of replenishing of inventory to do in the coming years, and that means oil services companies like Schlumberger are going to benefit immensely.
Look beyond the headlines
The oil market gets a lot of attention from the financial media, but so much of it isn’t that useful to long-term investors because it is so narrowly focused on things that will likely influence oil prices for a day, a week, or if we’re lucky, a month. As Schlumberger’s management has pointed out, several of the things that make the headlines don’t tell the entire story, and investors should look at the longer-term trends in the industry to get a better feel for how to invest in oil stocks.
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