By: Gene Walden, Senior Finance Editor May 01, 2017
The oil industry has been through a bumpy recovery since hitting rock bottom in February 2016 when West Texas crude dropped to under $27 a barrel. But prices have nearly doubled since then and production in the U.S. has been steadily ramping up. In the video and transcript below, we hear from John Groton, Director of Equity Research for Thrivent Asset Management, on this very matter.
John, could you give us some insight into the driving forces behind the oil recovery?
John: Absolutely. Simply, supply and demand responded to low prices as Economics 101 would dictate. Supply dropped by over one million barrels per day last year because the number of rigs drilling for oil dropped by 80%. That was just a reflection of drilling new wells not being economical.
Demand increased also, as you would think it should. People drove more. Vehicle miles traveled is up a lot year over year, and people are buying bigger SUVs. But the industry is always cyclical and this was a typical cycle with lower supply and higher demand starting the new cycle.
Have the jobs started coming back in the oil industry?
John: Yes they are. The raig count off the bottom has more than doubled and every one of those new rigs has a crew working on it. Across the entire energy sector, jobs are increasing with that increase in activity.
How about the earnings of the oil industry?
John: Those will be an important factor for overall market earnings this year – how much earnings will grow year over year. The increase in commodities prices almost always goes to the producers’ bottom line. Taxes will be higher, royalties paid to landowners would be higher. But profitability due to a change in commodities prices goes up a lot. That’s the first order effect. Then those producers take that cash flow and drill more wells – more activity as we just talked about. Then the oil field services companies that have the products and services that actually drill wells – their earnings will also increase a lot versus last year.
OPEC has been cutting production, but the U.S. has been ramping up production. What’s the net effect of that?
John: OPEC has been very disciplined with their cuts since their meeting last November – that’s worth mentioning. And it is true that U.S. production has been increasing because of the increase in activity. But one thing that most people don’t think about is that almost half of the world’s oil production comes from outside of OPEC and outside the U.S., and activity there also dropped dramatically last year. That will affect supply going forward. Demand has been very strong worldwide and, even with our ramping up, it appears that supply and demand will be in a much better balance this year.
Is there a happy medium in oil prices – oil companies are earning a profit and consumers are still paying under $3 per gallon?
John: As we invest in oil companies, we do want those companies to earn a return on capital. The oil price necessary for that varies by company, but it’s in the $55 to $65 range. For OPEC countries, that’s probably ok, but they may need prices a little bit higher. At the $55 to $65 level, gasoline prices likely do stay under $3 per gallon.
So you see prices continuing in that range?
John: For this summer, I think that’s fair. But a lot can happen in the oil markets. The rule of thumb is a $10 change in oil price works out to a 25-cent per gallon change at the pump, so we do have room for higher oil prices and still have gasoline for under $3 per gallon this summer.
All information and representations herein are as of May 1, 2017, unless otherwise noted.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management associates. Actual investment decisions made by Thrivent Asset Management will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.
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