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Why Oil Prices Will Hit $60-$65 By Year End

While recent market volatility has roiled equity markets investors, oil prices have matched their ferocity in price dips causing leading market prognosticators to predict a bottom somewhere in the $20's. The precipitous price has caused turmoil in the oil patch and wreaked havoc in the high yield market further exacerbating investor uncertainty. I haven't had a history of calling market bottoms but in terms of lower prices, the existing maxim is that the lower a price goes—the shorter a time period the price will stay there. My personal expertise has been forecasting realistic future values, so I believe that I will stay focused on that. In terms of making those forecasts I took some cues from a legendary oil investor, Harold Hamm, Forbes #65.

Harold Hamm echoed the lower price for shorter period sentiments today while categorically stating that oil was at an "inflection point". This is an important quote because Mr. Hamm is currently worth over $5.2 billion from his expertise in the oil and gas industries (this is a decrease from the $7.4B last year due to the precipitous drop in oil). Most will know of Mr. Hamm because of the $1 billion dollar divorce settlement check that he famously sent to his wife who initially rejected it. So it is safe to say that Hamm knows a little about volatility in combination with dexterity and therefore should be listened to.

‎There are a number of technical and factual reasons to support his inflection point thesis.

The main driver behind the lower price was a concerted shakeout of the shale producers by OPEC. The technology of vertical drilling was pioneered by Mr. Hamm and it created prodigious wealth for a number of entrepreneurs. Saudi has been named as the main culprit of the price shakeout due to the release of their excess capacity of $1.8m barrels since the end of 2014. This is approximately 2% of the market and created an excess of over $2m barrels in the market. However, investors should expect this margin to narrow as excess capacity has been absorbed over time due to a steady reduction in production.

An additional factor is that US Shale can now be exported to other markets. The producers were previously captive to US refineries making the price effectively 20-25% less creating a more level playing field for all competitors. Due to this change, within 11 hours of trading West Texas Intermediate (WTI) went to a premium price due to the market mechanics and the the possibilities of exporting. Rest assured that there is a considerable case for exportation given that capacity exists and the additional factors of considerable demand, existing infrastructure, shipping and distribution with shipments already going out. In combination with these factors is that banking and legal system are more favorable for business in the United States.

Finally, drilling has been shut down 75% over the last 14 months, experts expect a rebuild of capacity to be approximately 14 months. As a matter of fact, horizontal drilling has doubled in the U.S and is used to accelerate production in tight rock with decline rates increasing historically higher of upwards to 70% which over time (4-5 years) decrease to around 20%. Traditional decline has been between 4-6% making the decline rate 3 times higher. Expect decline rates to drop faster and be aware that there are lots of declines to overcome.

These dynamics will lead to a low oil supply situation, investors should expect to see prices hit $60-$65 by end of the year.

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