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Relatively controlled oil prices that aren't going to go significantly higher seem like good news for the global economy. But with everything that's happening in the world at the moment, are they going to stay at these levels?
We should see oil prices stay around current levels. With the events in the Middle East, people were expecting a major spike, but you have to realise that, right now, supply and demand are roughly in equilibrium.
At the heart of this is what the oil market thinks about demand next year, right?
Something that’s important to remember is that yes, we are roughly in equilibrium right now, but Opec is holding significant supplies out of the market. And that’s what's held prices in this vicinity.
Yes, Opec could flood the market and crash prices. But thinking about the spending that Middle Eastern countries are planning as they build out their own economies, it’s not in their interests. This is unlike 2014-16, when US shale was growing a million barrels of production per year, multiple years in a row. Now, the US shale companies in particular are acting more like adults. They're generating lots of cash, but hardly any growth. And that's quite a good thing for the oil companies right now.
They aren’t borrowing hand over fist to fund new wells?
You could certainly see some growth in output again. If you look at the plans for companies like Exxon and Chevron, for example, they call for some shale growth. But for the most part, the small companies - especially the high yield companies that created much of the froth ten years ago - these companies have learned their lesson. They fixed their balance sheets. They're generating lots of cash. And I don't expect to see them out-spending cashflow going forward. The markets do not want that.
How is the impact of ESG concerns playing out in the industry?
It is ironic that ESG actually has been very, very good for these oil companies. You wouldn't think that would be the case. But if there's less demand for oil going forward, companies are going to spend less on new projects. And the reduction in longer-term investment and the knock-on to supply has been a tailwind for prices. So these companies are generating more cash, far more than is usual.
The equity market doesn't seem to care about these small companies, but they're buying back 10 to 15 per cent of their share count in any one given year. And their wells are considered short cycle, which means that if oil prices stay around these levels, you can make your money back in a year or less versus a five-year project with a long cashflow trail.
What is the biggest risk facing the sector at the moment?
The biggest fear would be some kind of major escalation in the Middle East, and that would certainly spike oil prices. But again, that’s not expected. There's lots of excess supply out there. Right now, 18 million barrels a day go through the Straits of Hormuz and it is always the big risk, but it has never closed before. Through the Iran-Iraq War, and the invasion of Iraq - nothing has ever stopped the oil from flowing in that part of the world.