Lagos Nigeria -17 October 2018: Iranian and Venezuelan oil production levels, along with the pace of US shale growth, will drive oil prices in the medium term, Fitch Ratings says. Supply constraints at a time of steadily growing demand are leading the Brent price to spike above USD80/bbl.
We rate oil and gas (O&G) producers on a through-the-cycle basis using fairly conservative price assumptions, but there is a potential for a moderate upside revision of these assumptions in the next two months.
Upcoming US sanctions against Iran already caused the country’s output to drop by 350 thousand barrels per day (mbpd) in September. We believe at least 1 million barrels per day (mmbpd) may be at risk unless sanction waivers and exemptions remove pressure to cut production further. Venezuelan output in September was 700 mbpd below its OPEC quota as the economic and political crisis continues to cripple the country’s oil industry.
We forecast that production declines in Iran and Venezuela may reach 2 mmbpd, or more. This is about the same as our estimate of maximum global spare capacity at the beginning of the year, mostly in OPEC countries and Russia. Prices might come down if OPEC+ producers manage to make up for the lost volumes.
US shale growth could help the oil market revert to a more balanced state in 2019 with prices moderating. However, the very limited spare capacity left in the market is likely to continue to influence prices. We cannot rule out an alternative scenario where oil prices keep rising or stabilise in the USD80-90/bbl range should OPEC and Russia be unable to sustainably offset the production fall.
The pace of US shale growth will be a significant factor in the oil price level. The US Energy Information Administration (EIA) expects US crude production, including natural gas liquids, to grow by around 2 mmbpd in 2018, which should exceed global demand growth. However, infrastructural limitations will continue to limit by how much the US production could grow every year. There are several large pipelines with expected completion dates in 2019 and 2020 that will somewhat elevate constraints.
Oil demand is expected to remain strong in the short term but is more uncertain over the next two to three years. Global economic expansion at the beginning of the year has spurred the demand. However, protectionist US trade policies have now reached the point where they are materially affecting the global growth outlook. High oil prices may also start to weigh on demand.
The credit profiles of deeply high-yield O&G producers are likely to benefit from the current pricing environment. This is due their liquidity positions often being stretched and leverage high, so additional cash flows could remove liquidity pressure and reduce debt loads. Larger integrated producers usually match increased cash flow from higher prices by increasing returns to shareholders, so the impact on their credit standing is more limited.
We expect industry cost inflation to pick up if high prices are sustained. So far, most large players have based their budgets on the USD50-60 price range. Plans may change if oil prices remain high.