Traditional energy companies are having an identity crisis. Despite a strong profit outlook heading into 2022, enormous pressure is coming from providers of capital and other stakeholders to evolve business models for the new energy economy, as we’ve seen with examples like Shell, ExxonMobil, etc. Let’s examine the price dynamics in the oil and natural gas markets that will impact the energy sector as we head into 2022.
Oil Prices Remain Constructive
In oil markets, expect the next year to feel a lot like the last few weeks—we're in for a volatile ride. Fundamentally, demand is expected back at pre-pandemic levels, but government reactions to new variants, Iran news or actions, or any discontent within the OPEC coalition have the potential to create plenty of noise. We're modeling that the OPEC agreement to continue with its planned increase in the group's January production quota will keep prices below $80 per barrel for the next several months. We expect that the global balance moves again to a surplus midyear, pushing prices slightly lower.
But taking a step back as to what these prices mean to oil producers and the sector, the outlook for near- and medium-term profits is as constructive as we've seen in a decade. The median cost to produce in U.S. shale plays is $35-40 per barrel. Prices above $60 per barrel provide meaningful margin for returns to investors and to balance sheet improvement. And key to this is stakeholder pressure on traditional oil and gas companies to show consistent returns and not reinvest in growing supply in the face of the impacts of the energy transition. It's enforcing capital discipline the sector has lacked since the advent of shale.
Natural Gas Prices Come Down to Earth
If you took an extended Thanksgiving break, you missed the biggest one-week decline in natural gas prices since 2014. Winter strip pricing has been crushed, down $0.85 since the end of November. Summer strip pricing has not been hit as hard and remains just under $4/MMBtu. Continued trends in warm weather could give us $2 gas this summer. We were bearish when we published our latest forecast at the end of November and we're still bearish on the current trend.
Capital Discipline Reigns
In the U.S., public independents continue to practice capital discipline, which has been the key differentiator in keeping global markets balanced. Instead of reinvesting capital in the field, those exploration and production companies (E&Ps) are instead favoring flatter production with cash flow reinvestment rates between 50% and 70%. Excess cash flow has been and will continue to primarily be used to reduce debt levels. So far in 2021, a group of 30 E&Ps has paid down roughly $9.4 billion in debt, more than the $8.2 billion increase in debt that producers took out in the early days of the pandemic. Based on public producer debt targets and current strip pricing, BTU Analytics models that the majority of debt reduction will be completed by mid-2022. At that point in time expect more cash to be returned to investors through variable dividends and stock repurchases.
Market commentary from December 8, 2021. Listen to the MKT 2022 Outlook Webcast to hear Ms. Miller and other FactSet thought leaders discuss recent trends and events to watch in the key areas of Earnings, Energy, and ESG.
Disclaimer: The information contained in this article is not investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
Ms. Kathryn Downey Miller is VP of Energy Strategy at FactSet. In this role, she leads the delivery of services to clients across all sectors of the energy industry and oversees strategic planning, financial budgeting, and analyst development. Prior, she built market expertise in a diverse set of industry roles that included buyside investment research at an energy-focused hedge fund, energy market fundamentals consulting at Bentek Energy, investor relations strategy consulting for exploration and production (E&P) companies, and investment banking at Citigroup. Ms. Miller earned a degree in finance from the George Washington University School of Business and is a CFA charterholder.
The information contained in this article is not investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.