Giddy Up! It's Time to Get Back to Work!

Maximum Price in Futures Curve (v2).png

Prices have stabilized and even started increasing in the futures curve.  Now it's time to get back to work.

Commodity prices comprise an equal half of the equation for oil company revenues. The dramatic and painful drops in spot prices over the last years captured headlines, but the more fundamental change in mid to longer term prices slowly evolved. While the contango persisted, its magnitude and slope diminished as expectations of recovery dragged out and down. New production was deferred, at least some, in hope and faith for the return of higher prices. That time has now come since current prices have mostly converged with expectations of the future.

By May and early June, both oil and gas prices reached levels very near the medium term forward strip. NGLs also rallied. While there has been some retreat in spot prices since that time, the out years of the futures curves have continued to increase in the last two months. Oil is up over 15% above its nadir, and gas is up even more. The chart below shows the maximum value in the futures curves for oil and gas over the last couple of years.

Starting in February by "terrorist" sabotage in Nigeria and mainly sustained by the same kinds of interference, oil spot price nearly doubled over a few months' time, even despite supply growth from important quarters. Shyly and quietly, gas has made its own bull run in the last half year equal to, if independent from, that of oil. The current one is the most sustained rally seen in long-term expectations in years.

Besides the "voting" in the futures market, analytical procedures like those of the EIA and IEA estimate a fundamentally consistent future price for oil. The EIA's econometric models for short term outlook suggest modest contango into the future as shown below.

From several sides, the overall outlook on near and far prices seems much better than it has in years, and the effects of the convergence of price expectations on rig count was fast. Starting in late May, rig counts turned up as well. By last Friday, total rig count was up 14% over its bottom, and all of that oil-directed. Oil rigs are even returning to plays like Niobrara and Woodford in addition to the Trinity (Permian, Bakken, Eagle Ford).

Prices are now about as high as we can expect them to be in the foreseeable future. They will, of course, remain volatile for a while, but that isn't necessarily bad. Volatility creates opportunity for opportunists while hedging creates safety for conservative players. As demonstrated by the recent uptick in rig count, it is time to get back to the business of the other half of revenues -- production.

It will be interesting to see how quickly and how effectively the supply responds to the price signal; supply might even overcompensate and send prices back down. What do you think will happen? Will we bring on too much supply or too little in the rest of 2016?

 

See this post on my LinkedIn page.