The Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy exchange traded fund, is still saddled with a year-to-date loss in excess of 10% and the energy sector is still the worst-performing group in the S&P 500, but some market observers believe those themes will change in favor of energy bulls.
Declining prices in recent years have prompted scores of major oil producers to rein in capital spending. Technological improvements and greater efficiency has helped U.S. shale producers pump out crude oil at lower margins – some say it is now profitable at less than $50 per barrel. Additionally, companies are finding easy access to credit and private-equity firms have bought out struggling companies, which have kept production flowing.
“We believe that the undersupply situation will happen much sooner than many people expect. In Q4 2017, we are already estimating a 2 million b/d deficit. This comes from a combination of our bearishness on non-OPEC supply and a more realistic look at global demand,” according to a Seeking Alpha analysis of oil markets.
While many oil market observers believe a rise to $60 per barrel is necessary to fan the flames of a broader rally, over the near term, the $50 per barrel is key.
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Advances in U.S. shale oil production technologies are contributing the to supply surplus and weighing on any oil price gains. It has become much cheaper for the upstart U.S. shale producers to extract oil out of the ground, but the growth rate of U.S. oil product has also recently slowed.
“Everyone’s confidence has been hinged on the idea that U.S. shale would give us enough supplies, when in reality (as our work has shown) it’s not going to happen. There is near perfect consensus out in the market place today that U.S. shale will be the harbinger of supplies. Productivity gains and lower break-even have prompted people to call U.S. shale as the new “swing producer,’” notes Seeking Alpha.
Citigroup also projects a greater likelihood of persistent shortage of oil than a big jump in supply over the coming quarters. Ed Morse, global head of commodities at the bank, said that a handful of Organization of Petroleum Exporting Countries might already be pumping at maximum capacity already, and due to weak investment in exploration and development, there is a greater risk of a market squeeze once demand picks up, especially from a growing Chinese economy.
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