Oil Prices: Is a Major Rebound on the Horizon?

By Matthew DiLalloFool.com

Shell CEO Ben van Beurden. Photo credit: Royal Dutch Shell's Flickr page.

After falling 8.4% in September, and 24% for the third quarter, the price of oil has started to recover in October. Even more gains could be on the way. This is according to the CEO of Royal Dutch Shelland the secretary-general of OPEC, both of whom see signs on the horizon that suggest oil prices could move higher.

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A light at the end of the tunnelWhile neither is outright bullish at the moment, Shell's CEO, Ben van Beurden, told attendees at a recent conference, "I see the first mixed signs for a recovery in oil prices." Chief among those signs is the dramatic drop in oil and gas investments, which is expected to lead to lower oil supplies. That, according to OPEC secretary-general Abdalla Salem el-Badri, has a very direct relationship to oil prices. As he noted, "Less supply means high prices."

Overall, oil companies cut $130 billion in spending in 2015, which is 22.4% lower than last year. That reduction is the "highest drop in history," according to the International Energy Agency. Meanwhile, more spending cuts could be coming in 2016, as Barclays, for example, sees an 8% drop in global oil and gas spending, while Citi sees a 15% to 20% drop in U.S. oil and gas spending.

That spending drop, particularly in the U.S., where oil producers are struggling under a weight of debt, is causing production in the U.S. to finally roll over after its dramatic climb the past few years.

US Crude Oil Field Production data by YCharts

As spending cuts deepen, it suggests further declines for U.S. production. In fact, Mark Papa, the former CEO of EOG Resources, recently told attendees at a conference, "We are about to see a pretty dramatic decline in U.S. production growth." Production could in fact drop by 1 million barrels per day from its peak of roughly 9.6 million barrels, according to some estimates. This is why el-Badri commented that OPEC sees "some light at the end of the tunnel" in terms of an oil-price rebound.

High oil now prevents really high oil laterWhile higher prices are good for the near term since they'll solve some of the issues in the oil market and really help struggling U.S. producers, it's even better for everyone else over the longer term. That's because the reduction in oil and gas investments will not only lead to near-term supply reductions but could also potentially lead to an even steeper longer-term supply problem, since fewer long-lead-time projects, such as those in the oil sands and the deepwater, are being sanctioned right now. The lack of major project investments could lead to a significant reduction in the oil market's spare capacity in the future, which is something both van Beurden and el-Badri are concerned about.

Photo credit: Royal Dutch Shell's Flickr page.

Shell's CEO noted that such a scenario of continued significant under investment could, in a few years, "cause prices to spike upwards, starting a new cycle of strong production growth in U.S. shale oil and subsequent volatility." This potential price spike is also a concern that the OPEC secretary-general has warnedis a possibility, saying that "if you don't invest in oil and gas, you will see more than $200" a barrel for oil. While a lot would need to happen for that to become a reality, such as a strong global economy fueling robust demand for oil at the same time a major oil-producing nation goes offline, it's a scenario that has a heightened risk in the later part of the decade.

Investor takeawayWhile no one is ready to declare that the downturn is over, there are signs that oil prices might go a lot higher. That would be a relief to the industry, since it could prevent many in U.S. oil industry from going belly-up, providing them with more cash to help alleviate their debt issues. Even more importantly, it would provide larger producers with the cash they need to increase investments in major projects so that they can develop enough resources to meet future demand, which could help to prevent a huge future spike in oil prices.

The article Oil Prices: Is a Major Rebound on the Horizon? originally appeared on Fool.com.

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