S&P Global Ratings Raises Its Oil And Natural Gas Prices Assumptions For 2017

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S&P Global Ratings has reviewed and updated its price assumptions for Brent and West Texas Intermediate (WTI) crude oil. We’ve also raised our U.S. natural gas (Henry Hub) price assumptions. We increased our oil price assumptions to $50 per barrel from $45 per barrel for 2017 and raised our Henry Hub natural gas assumptions for 2017 to $3.00 per million British thermal units (mmBtu) from $2.75 mmBtu. All of our other price assumptions are unchanged (see table).

We use our price deck to assess sovereign and corporate credit quality, in particular for exploration and production (E&P) companies, in accordance with the methodology set forth in “Methodology For Crude Oil And Natural Gas Price Assumptions For Corporates And Sovereigns,” published Nov. 19, 2013, on RatingsDirect. These changes are nominal and will have very little impact on ratings.

S&P Global Ratings’ Oil And Natural Gas Price Assumptions
New Prices Old Prices
Brent WTI Henry Hub Brent WTI Henry Hub
Rest of 2016 N/A N/A N/A 42.5 42.5 2.5
2017 50 50 3 45 45 2.75
2018 50 50 3 50 50 3
2019 and beyond 55 55 3 55 55 3
Prices are rounded to the nearest $5/bbl ($2.5/bbl in 2016) and $0.25/million Btu. bbl–Barrel. Btu–British thermal units. WTI–West Texas Intermediate. N/A–Not applicable.

The revisions to our oil price assumptions follow the agreement by members of the Organization of Petroleum Exporting Countries (OPEC) to cut production by 1.2 million barrels per day (mmb/d) in concert with a reduction of 558,000 bbl/d by non-OPEC members. In the context of oil demand growth projections of about 1.3 mmb/d for 2017 from the International Energy Agency, we believe even a partial implementation of the agreed total of 1.8 mmb/d cuts will probably bring the market closer to a balanced position and is likely to support prices. We consider these persistently high levels of crude and oil product inventories have been key in dampening upward price moves over recent quarters.

Our near-term oil and natural gas price decks broadly reflect our assessment of futures price curves, which remain flat, because we recognize the typical volatility of these market indicators. We base our long-term price assumptions mostly on fundamental analysis incorporating our assessments of the marginal cost of oil and gas production and supply and demand.

Our long-term price deck assumptions mostly reflect the significant industry cost deflation that is currently taking place. Declining costs come after a decade of inflation, thanks to engineering optimization, improved drilling efficiencies, and production cost reductions, especially in the once high-cost U.S. shale formations. Drillers, forced to improvise because of the low prices, have introduced new drilling methods, fracking, and well-completion techniques that have resulted in more permanent cost reductions.

We continue to assume no significant difference between the prices of WTI and Brent oil, based on both the feasibility of U.S. crude oil exports and our observation of this spread being generally much less than $2.5 per barrel year to date.

OPEC’s Announcement Will Establish A Floor On Pricing

The immediate reaction to OPEC’s announcement was a spike in current prices and, at the very least, it put a floor on prices.

However, it’s interesting to note the slope of the price curve–the long-dated prices barely moved in relation to near-term prices. The curve clearly reflects that this agreement is only for six months and that there is no guarantee that it will be extended. It could also reflect trader concern over OPEC and non-OPEC compliance. Historically, OPEC members haven’t always complied with their agreements, and for countries like Iraq, who clearly aren’t benefitting from bloated inventory levels, might have incentive not to comply. However, lower seasonal demand could support adherence to the quotas. Also, Nigeria and Libya, which are exempt from the agreement, have already raised output since October and will probably continue to average higher than those levels.

The curve also might reflect the potential for U.S. shale production to pick up rather quickly. A close look at well economics indicates that $50 per barrel appears to be a bogey for shale production. At $50 per barrel, some shale production is economical as demonstrated by the increasing rig count and increase in hedge volumes this past year. Companies took advantage of the spikes in commodity prices to lock in returns and guarantee production next year.

Natural Gas Production Growth Pauses Due To Weak Prices

We’ve seen an increase in natural gas prices due to lower injection rates brought on by:

  • The past few years of declining natural gas rig count finally having an effect;
  • Lower associated natural gas production from lower oil and natural gas liquids drilling; and
  • An unseasonably hot summer.

We continue to see an underlying shift occurring in the U.S. natural gas production profile. Production growth has veered from the Southeast to the prolific Marcellus and Utica shale formations in the Northeast. We don’t believe Marcellus and Utica have reached their full production potential.

We expect that a significant increase in infrastructure takeaway capacity over the next few years will narrow regional price differentials and lead to ongoing production increases. Production from these shale formations is extremely low cost, in part due to the general decline in oilfield service costs and stacked plays. And producers are quickly able to meet any uptick in demand by, for example, increasing power generation, industrial production, or liquid natural gas exports. This effectively creates a cap on prices and results in the backwardation of the futures curve.

The boom in U.S. shale oil drilling in recent years has also produced natural gas as a by-product of oil extraction. While production of associated gas has slowed as shale oil production has fallen over the past year, any meaningful recovery in oil production will add volumes of gas that are insensitive to changes in gas prices.

The price assumptions described in this article are effective immediately.

Related Criteria And Research

Related Criteria
  • Methodology For Crude Oil And Natural Gas Price Assumptions For Corporates And Sovereigns, Nov. 19, 2013
  • Corporate Methodology, Nov. 19, 2013
  • Key Credit Factors For The Oil And Gas Exploration And Production Industry, Dec. 12, 2013
Related Research
  • The Rally In Oil Prices–Is It Sustainable?, June 28, 2016

Mira Dalal contributed to this article.

Primary Credit Analyst: Thomas A Watters, New York (1) 212-438-7818;
thomas.watters@spglobal.com
Secondary Contact: Simon Redmond, London (44) 20-7176-3683;
simon.redmond@spglobal.com
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