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Oil

Shale is the name of the game

The WTI oil price ended June around USD 74 per barrel, up just over 10% for the month. Shares of shale oil producers gained 1.9% on average (XOP index), while our selection posted a flat return.

CrudestocksSource : Bloomberg

After Russia and Saudi Arabia communicated their intention to raise production by up to 1 million barrels per day (merely to offset the ongoing collapse in Venezuelan output) and President Trump started to increase pressure on other Western countries to stop importing Iranian oil, investors began to realise that the market will remain (very) tight and that crude is likely to pursue its upward trend.

Due to full occupancy of “in-basin” refineries and a shortage of available pipelines from the Permian basin to the Gulf coast, many shale producers that did not secure sufficient pipeline capacity are currently drowning in their own oil and being forced to accept lower prices. The excess (and still growing) production must first to be pumped north to Cushing, Oklahoma, from where it can then be pumped through the Seaway Pipeline down to the Gulf coast. Or else, it must be driven by truck to the Gulf coast, a very inefficient and costly option. As a result, the average price paid for a barrel of oil produced in the Permian basin now stands around USD 62, well below the USD 74 WTI price. This pricing gap mainly reflects the higher transport and storage costs. The profitability of Permian shale oil producers will remain under pressure until this pipeline issue is resolved – not an immediate prospect since no new capacity is expected before the end of 2019.

And there is more. Due to a lack of tanker loading facilities at the Gulf coast, part of the production is difficult to export out of the US for the time being, creating oversupply in the domestic market. Extra tanker loading terminals are under construction but, here too, it will be some time before they are operational.

These factors explain why shale oil shares did not trade up alongside the WTI price in June. Renowned market observers even think that the pricing spread between Permian and WTI crude (which reached USD 12 in June) could widen to USD 20 during the coming months.

Some patience will thus be needed before shale oil shares experience their next leg up. That said, we are invested in top notch producers, most of whom have secured pipeline capacity and already sold forward part of their future production. Also, they all trade substantially below their net asset value. Selling them now with a view to taking advantage of potentially lower share prices later in the year to step back in does not seem to us a wise strategy. Odds are too high that the oil price will continue to rise, which should also benefit shale oil producers even if the spread does widen further.

(update : 07.2018)