Quarter-End Insights

Energy: Looming U.S. Shale Supply Should Temper Optimism

Joe Gemino, CPA
  • Crude fundamentals look healthier than they’ve been for years, largely due to voluntary curtailments from OPEC and its partners. By giving up 1.8 million barrels per day combined, this group has engineered a temporary supply shortage in an effort to realign global inventories with long-term averages.
  • Helping OPEC’s efforts, the precipitous decline in Venezuela’s output during the fourth quarter of 2017 has proved far steeper than expected and will most likely prop up oil fundamentals for most of the year.
  • However, growth from U.S. shale still looms large. Crude prices have largely held above $60 per barrel for West Texas Intermediate in 2018, which provides an attractive economics for many U.S. producers. Eventually, we expect pain for oil prices as growing U.S. production serves as the primary weight to tip oil markets back into oversupply.
  • Our midcycle forecast for WTI is still $55/bbl. We think oil bulls are failing to recognize the vast potential for further productivity gains from U.S. producers and are unduly worried about prime shale acreage running out more quickly than it really will.
  • Despite our bearish outlook for near- and long-term oil prices, we see pockets of opportunity in the oil and gas space. Energy sector valuations look modestly undervalued at current levels, with an average price/fair value estimate of 0.94. Still, on a relative basis, energy is one of the cheaper sectors, with several others trading at a price/fair value above 1.03.

Joe Gemino, CPA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.