Oil Market Update - Dec 20

[dan_s]

Oil Market Update from Josh Young at Bison Interests 12-20-2024

OPEC recently extended its production cuts by three months to April 2025 and termed out the unwinding of the cuts to 2026, effectively removing 305 million barrels of cumulative production, or 0.84 million barrels per day (mbd), from the 2025 oil market.

Despite this reduction, the price of WTI has remained relatively flat, hovering near three-year lows, as the prevailing sentiment suggests an oversupplied oil market in 2025.

We disagree. The oil market experienced nearly a 1 mbd deficit in 3Q24, rig counts are down 5% year-over-year, and oil majors Chevron and Shell have recently announced capital expenditure cuts, reflecting the industry’s shift toward shareholder returns over growth. As a result, non-OPEC production growth is not expected to meet 2025 global demand (according to EIA projections), leaving OPEC to fill the gap. Bears may argue that OPEC has ample spare capacity, but spare capacity is not the same as actual production and overlooks the more important factor: OPEC’s pricing strategy. < MY TAKE: At the current active rig count, there isn't much chance that U.S. oil production can continue to increase.

OPEC has the ability to adjust its production levels to maintain or raise global oil prices. Due to high production growth from the U.S., Canada, and Guyana over the past three years, OPEC has chosen to cut output to support prices. This dynamic is likely approaching an inflection point, as non-OPEC growth is projected to fall short of meeting 2025 global demand. This shortfall will create a call on OPEC, making consumers reliant on OPEC barrels to balance the market.

The call on OPEC will give the group leverage to set prices by allowing them the option to withhold barrels to drive up oil prices. This raises the question: what price is OPEC aiming for? While the group has never explicitly stated a target, their intentions are evident from previous cuts and extensions, including at prices as high as $85 WTI—significantly higher than current levels. Also notable, Saudi Arabia, OPEC's largest member, requires an oil price of $96 to balance its budget, underscoring the group's incentive to push for higher prices.

Shifting market dynamics are giving OPEC greater leverage, and beyond 2025, we expect OPEC’s influence to grow as rising global demand continues to increase. Ultimately, exhaustion of OPEC spare capacity could lead to much higher pricing in the future if this longer term demand trend continues.

We think this trend is poised to create highly favorable conditions for oil producers next year and through the end of the decade. Our portfolio is aligned with this thesis, and we believe the companies we’re invested in are deeply undervalued, even compared to the other already discounted small to mid-cap equities. < The same can be said for our Sweet 16 Growth Portfolio. Plus, rising natural gas prices will offset the revenue impact of lower oil prices for most of the Sweet 16 in 2025. If oil prices rebound in 2H 2025 there is significant upside in our Sweet 16 .

In a rising commodity price environment, our portfolio companies benefit from a dual effect: higher intrinsic values and multiple expansion as their valuations revert to industry standard levels. Oil and gas is a cyclical industry, and with prices currently low and companies announcing reduced capital expenditures for 2025, we believe we’re closer to the bottom of the cycle than the top. As a result, we’re excited about this opportunity to capitalize on the current low pricing and valuation environment.