Pessimism is pervasive in the oil patch these days. Analysts are slashing their oil price forecasts, with many making dire predictions. Driving this downbeat attitude is the fact that, despite OPEC's efforts to drain the market's supply, oil inventories remain well above their five-year average. The culprit has been a combination of weaker demand growth and higher production from U.S. shale producers as well as Libya and Nigeria, which are exempt from OPEC's output reduction efforts.
That said, recent data suggests that industry fundamentals are getting better. In fact, if these current trends across three key industry metrics continue, crude prices could start rebounding in the coming months, which would be great news for oil stocks since they should ride that wave higher.
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Demand growth is accelerating
In mid-July, the International Energy Agency (IEA) released its monthly oil market report. One of the numbers that stood out in that report was oil demand. The Agency found that, after expanding by a lackluster 1 million barrels per day (MMbpd) in the first quarter, global oil demand growth accelerated to 1.5 MMbpd in the second quarter. Because of that, the IEA revised its 2017 demand forecast up by 100,000 bpd to 1.4 MMbpd. Meanwhile, it sees oil demand expanding by another 1.4 MMbpd next year, putting global oil consumption at 99.4 MMbpd.
Oil inventories are draining faster than expected
That acceleration in demand, when combined with OPEC's output cuts, resulted in a noticeable draw on U.S. oil inventories in recent weeks. According to the U.S. Energy Information Administration (EIA), crude stockpiles fell by 7.6 million barrels last week, which was well ahead of the 2.85 million barrel consensus estimate. That followed a 6.3 million barrel draw in the prior week, which again was more than triple what analysts had expected. While oil inventories remain in the upper half of the five-year range for this time of year, they've been draining at a brisk pace in recent weeks. If that trend continues, it will show that the oil market is tightening, which could be the ticket to send crude prices higher.
Shale producers just might be tapping the brakes
One of the reasons the price of oil has remained well below expectations this year is due to a surge in output from shale producers. Companies like Devon Energy (NYSE: DVN) have reported expectation-thrashing production results. In Devon's case, its first-quarter production came in a stunning 5,000 bpd above the top-end of its guidance range thanks to robust well results. Devon has continued to report impressive numbers, and recently announced that a well in the STACK play hit a peak rate of 6,000 barrels of oil equivalent per day, which set a new initial production record for Oklahoma "by a wide margin."
Meanwhile, Concho Resources (NYSE: CXO) and Marathon Oil (NYSE: MRO) both delivered guidance-beating first quarter production. In Concho Resources' case, it achieved 13% quarter-over-quarter organic oil growth thanks to strong well results in the Permian Basin. Marathon, on the other hand, benefited from a 7% sequential increase in oil output out of its Eagle Ford assets during the quarter.
Those strong first-quarter results led all three companies to either confirm or raise their full-year production growth targets, with both Concho and Marathon anticipating 20% to 25% production growth this year. Forecasts like those led the EIA to increase its U.S. oil production estimate, which it now sees averaging 9.3 MMbpd this year, an increase from 8.9 MMbpd last year.
However, recent data suggests that the decline in oil prices has shale drillers starting to tap the brakes on their activities. For example, according to oil service giant Baker Hughes (NYSE: BHGE), the rig count has either fallen or flat lined in two of the past three weeks. That's a noticeable slowdown since it had risen in 24 of the past 25 weeks. That seems to coincide with the fact that several drillers have said that they would slow their pace given where crude is these days. For example, Harrold Hamm, the CEO of Continental Resources (NYSE: CLR) warned his peers in a recent interview with CNBC to "back up, and be prudent and use some discipline...That's what we're doing at Continental and there are other CEOs I think that are probably doing the same thing." Meanwhile, WPX Energy (NYSE: WPX) is planning on running 10 rigs this year and add as many as three more in 2018 to accelerate its production growth. However, the company recently stated that it might not add any more rigs if current prices persist.
One thing that investors should pay close attention to is what drillers say about their plans for the balance of the year when they report second-quarter results in a couple of weeks. For example, Continental Resources' initial 2017 guidance called for it to add a rig and ramp up its well completion activities from five crews to seven, which would enable the company to produce 19% to 24% more oil by the end of the year. That said, given the comments by its CEO, the company might announce that it plans to run fewer well completion crews this year and hold its production back for when oil prices are higher. If several drillers announce plans to ratchet back their growth ambitious, it will show the market that they're serious about not drilling themselves into oblivion, which could send prices higher.
While the oil market isn't exactly flashing a buy sign, accelerating demand, huge drops in stockpiles, and a slowdown in the pace of shale drilling suggests that it might start tightening up. That scenario could send oil prices rebounding sharply later this year, especially if several shale drillers announce plans to scale back their overly ambitious growth programs. Such a rebound would likely take oil stocks with it, which means that now could be an excellent time for investors to buy top-tier oil stocks in hopes of riding that rally.
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