The recent dip in oil prices may prove to be the new normal, with barrels at $45 perhaps the only thing that can stem growth in U.S. shale output and ease pressure on prices, according to a new note from Goldman Sachs.
"Surging shale production shows few signs of stopping: whilst rig count momentum seems to be slowing feedback from our recent bus tour to Oklahoma & Houston suggests little evidence of stress at the US E&Ps, despite oil prices being significantly lower than the average $55/bl assumed in their 2017 budgets," the bank noted in a report on Monday.
West Texas Intermediate futures for delivery in July traded at $44.78 a barrel on Monday, marginally higher than their Friday price but well down from over $50 a month ago.
The prevailing prices have destroyed faith that OPEC's production caps can maintain prices at the cartel's unofficial target of about $55. It has also shattered the belief that shale production growth will falter at about $50 a barrel. Assuming the current oil rig count on U.S. shale fields holds, producers are likely to pump about 770,000 barrels of additional by the fourth quarter of 2017 compared to the same quarter last year.
The reason for that continued growth appears to be the high-yield funded business model that underpins smaller producers operations and encourages them to maximize earnings, even at the expense of profit.
"Some of the weaker balance sheet companies we met indicated that it was better from a leverage perspective to spend capital, even if above cashflow, to raise EBITDA, once again highlighting the role that credit is playing," wrote Goldman. "Ultimately, we believe a sustained period of $45/bl may be required to force activity lower in the U.S."
Not surprisingly, the dip in prices has hurt oil company investors. Shares in the U.S.'s biggest oil producer Exxon Mobil (XOM) - Get Exxon Mobil Corporation Report closed Friday at $83.49, down 7.5% since the start of the year, while Europe's top producer Royal Dutch Shell undefined is down 7.6% to 2,176 pence ($27.84) over the same period.
And things could get worse. Goldman noted renewed pressure from a build-up in U.S. reserves and recent weak U.S. gasoline demand, as well as about 1.5 million barrels of potential non-OPEC supply growth this year alongside the return of production from Nigerian and Libyan fields.
"There now seems to be broad-based acceptance that the back end of the (price) curve may be structurally pinned lower due to spare capacity and the resiliency of U.S. shale," wrote Goldman's analysts.