Davy Stockbrokers is forecasting a recovery and tightening in global oil prices in the second half of this year, adding that numbers can rise from the current $59 to $60 per barrel level to a long-term price of $80 per barrel.
“While the edge may have come off demand growth, the primary driver of weaker oil prices has been the relentless increase in US light tight oil or shale-based oil that requires controversial methods, such as ‘fracking’ to find] production and, to a lesser extent, sustained output from OPEC,” said Job Langbroek, Davy’s senior exploration and mining analyst in a new detailed report on the price of oil.
“We believe that US light tight oil will play the biggest role in determining oil pricing in the near future and possibly for the rest of the decade. While producing the same end product using the same industry technology, as a business model it is very different from conventional exploration and production.”
In its report, Davy also suggests that low oil prices will eventually lead to deferred drilling and a fall in production.
“This should begin to be visible in the second or third quarter and lead to tighter second-half crude oil prices. In the longer term, we think the progress in cost reduction, shown by the US light tight oil business and the depth of the service industry, will enable it to restart drilling when pricing recovers,” said Mr Langbroek.
“Our calculations suggest that to achieve average industry returns, a trading range of $70 to $90 per barrel is required. With this as a template, our long-term forecast sits in the middle, at $80 per barrel.
“We believe oil markets will recover later this year, as evidence mounts that not enough wells are being drilled to offset the rapid production decline characteristic of light tight oil production.
“However, light tight oil also has the capacity to rapidly react to improving price trends.”
Davy’s $80 per barrel price estimate is a long-term target, however. For this year, it is predicting an average international oil price of $55 per barrel, with that price rising to around $70 per barrel next year, “as the effect of sub-$50 local pricing effects is felt through the US light tight oil industry”.
“We assume a longer-term oil price of $80 per barrel,” Davy’s added. The light tight oil sector, the report states, is the largest player in the recent oil price decline drama.
“This business was a catalyst for the price fall and, as long as viable drill targets exist, will form an effective ceiling for prices in the future” said Mr Langbroek. “As the US tight oil play matures and reaches a plateau, the tension between technology, costs and geology may well throw up different scenarios. For now however, it remains the key to how the oil price will evolve in the next few years.”
Davy says its price assumptions will help Irish exploration firms.
According to Mr Langbroek: “We think Tullow Oil has the most leverage to a recovery in oil prices in the second half of the year. Its west African operations will be extremely profitable at an $80 per barrel realisation and, while not as stellar, the east African projects in Uganda and Kenya are fundamentally sound and undervalued at this long-term price assumption.
“At $80 per barrel, our valuation for Tullow is 561p per share, compared to a share price of 398p at present.”
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