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By Andrew J. O'Conor | 10-30-2017 02:00 PM

Higher Oil Prices, Cost Discipline a Plus for Energy Credit

It is unlikely to be a smooth ride, but we expect oil prices to gradually move up over the next year.

Andrew O'Conor: With support from especially sharp cuts to global exploration expenditures in the past three years and only a moderate rebound in upstream spending in 2017, we look for oil pricing over the next 12 to 18 months to seesaw higher--with bouts of volatility--in anticipation of gradually more balanced global supply/demand fundamentals. We foresee a WTI oil price range of $55 to $60 per barrel in 2018, unchanged from prior.

Since April, energy sector bond spreads have gradually tightened. Commensurate with our price outlook and a strict industry focus on costs, we think the overall credit quality of companies in the energy sector will continue to improve.

The main, near-term crude oil price concerns are, first, despite a steady, but modest decline since the beginning of 2017, global inventories of crude oil remain high. Within this, U.S. commercial crude inventories remain in the upper quartile of the average range for this time of year, although U.S. gasoline and distillate stocks have been more sharply drawn down, prompted by recent hurricane supply disruptions.

Second, U.S. shale oil production has rebounded significantly year to date and looks to inch higher in November, encouraged by the recent rebound in price. Assuming a more rapid runup in U.S. shale oil output than we currently envision could hold pricing back.

Lastly, OPEC and Russian oil production cuts expire at the end of March 2018. The consensus view is that OPEC will extend the cuts at OPEC's next meeting on Nov. 30. However, a rising price could tempt some OPEC participants to cheat on quotas, holding back price.

Further, concerns are partly offset by fears of more significant Venezuelan and Iraqi oil production outages caused by worsening political crisis there.

In sum, we expect the oil price to move higher in response to gradually tightening fundamentals, which bodes well for the overall credit quality of energy companies next year.

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