How to Succeed in the Next Oil Price Cycle

If there is one, fundamental thing to know about oil prices, it is this: Oil is a cyclical commodity. Sometimes prices are up, and then sometimes they are down.

Companies are built in the hard times, and they are destroyed in the good times. You just don't know it until the times change.

At this point, it seems to me that we have emerged and stabilized from the trough of the cycle, and, while the short term has more vagaries, the weight of large-scale factors suggests more upside than downside over the next few years.

  • OPEC created a more or less compliant coalition to continue to reduce supply,
  • disruptions of other supply has been sustained,
  • avenues of excess supply growth have become more limited,
  • demand continues to grow, though at a slower-than-expected pace,
  • limitations on the ability of the Permian to grow (renewed cost inflation, inevitable contraction of profitable areas),
  • the possibility of a major, international conflict has increased,

and, most importantly,

  • the drop in reinvestment over the last two years sets up a steeper supply decline in the near term.

Forecasts of prices by most in industry and currently most in Wall Street are like the forecasts of crude demand by the EIA and the IEA, they are fundamentally and persistently optimistic. Even so, I believe that consensus forecasts might undercall the price response coming in the next few years due to lack of investment. It is possible that the watershed turning of demand could follow closely on the heels of this next boom and could set up a long and deep bust. Almost certainly the path forward will not be as discrete as this, but there will almost certainly be another boom-bust cycle.

The following sentiment first appeared, to me at least, on bumper stickers in Midland in the 1980s:

Lord, grant me one more boom, and I promise not to screw it up.

But it has been just as true in the 1990s, the 2000s and now the 2010's. The process of planning and playing the cycle will prepare us to respond to whatever does happen. For now, I can recommend the following strategies regardless what exactly the future holds:

  • Remain vigilant: Pay close attention to unfolding trends, especially on oil demand growth. Ignore forecasts of demand and instead watch carefully for the flattening of actual demand since peak demand is likely to arrive without warning from public forecast models.
  • Buy low/sell high: Now is an advantageous time to buy (good) oil production, and better assets seem to be coming to market outside of the Permian. During the next boom, the volumes can be sold as assets or under futures contracts. Bear in mind that timing the absolute maximum price is a fool's errand and that it is better to miss the peak on the early side than the late side.
  • Create cost efficiencies: SCADA, automation and anything else which will lower costs now (and safely!) will keep the production alive in the next bust.
  • Diversify: Natural gas provides some diversification since the market is rapidly globalizing and is likely to grow much longer than oil. Other forms of diversification, though, may also be in order. 

DWAYNE PURVIS, P.E. advises clients about matters of strategic value including reservoir engineering and management. We would be pleased to talk with you about your unique situation and to help you to find a way to succeed.

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