Are you ready for $74 per barrel oil? In this interview with The Energy Report, RBC's John Ragozzino tells us he's anticipating a V-shaped oil price recovery that could bode well for upstream master limited partnerships, the companies that invest in oil and gas assets and have been hit hard by lower prices. He has followed MLPs through the highs and lows, and he knows which had the strength to hedge at the right times and which are liquid enough to take advantage of growth opportunities that could be right around the corner.
The Energy Report: John, oil and gas prices have rallied a bit recently. Have we established a bottom?
John Ragozzino: Yes. In our recently published Global Energy Research "Commodity Price Revisions" report, we are calling for a meaningful V-shaped recovery beginning in the back half of 2015 and into 2016. This is not significantly different from our prior forecasts, as we adjusted our price forecasts to $54 per barrel ($54/bbl) from $53/bbl in 2015, and from $77/bbl to $74/bbl in 2016.
Our thesis on crude oil is largely predicated upon a deceleration of non-OPEC supply growth, as we've seen the U.S. onshore rig count drop by more than half over the last five or six months. Additionally, we are seeing a growing inventory of uncompleted unconventional wells, as operators defer completions to an environment of better pricing and higher returns.
When you combine these two factors with a global demand picture that calls for roughly 1.0–1.1 million barrels (1.0–1.1 MMbbl) of annual demand growth over the 2015–2016 time frame, it doesn't take long before the global oversupply situation is largely eroded and we find ourselves back in a state of equilibrium. I think that will be the meaningful catalyst that gets us to higher prices in 2016. Our long-term deck remains unchanged at $84/bbl West Texas Intermediate (WTI) and $90/bbl Brent.
On the gas side, I wouldn't say that statement holds quite as well, because we continue to see new lows on Henry Hub natural gas prices. We can probably expect a continuation of anemic demand growth until the middle 2015, at the very least. That should mark the beginning of a phase of meaningful coal generation retirement, which could result in 2–3 billion cubic feet per day of additional demand. It's not until 2017 and beyond that we begin to see some meaningful changes on the gas demand side, with liquefied natural gas exports ramping up.
TER: Based on your new commodity price forecasts, what's the risk profile of upstream master limited partnerships (MLPs)?
JR: The upstream MLPs are at an elevated risk profile relative to historical levels. At the end of 2014, we believe the upstream MLPs were at a peak risk profile, as prices had been rapidly cut in half immediately after 18 months or so of market backwardation, when many management teams got ahead of themselves and veered off the well-beaten strategy path of robust hedging and price risk aversion measures.
Most upstream MLPs typically follow a rolling three- to five-year commodity price risk-aversion strategy that includes the use of fixed price swaps and costless collars to mitigate exposure to price volatility. Many upstream MLPs today are well below their preferred hedge levels due to the temptation to wait for better pricing during that long period of backwardation.
Management teams reluctant to take a $15-$20/bbl discount for their production volumes two to three years out held off on hedging at the worst possible time, as they saw prices cut in half as opposed to the forward curve simply returning to a normal state of contango. When the price continued to fall, a lot of companies that were crude oil-weighted effectively became victims of their own temptations.
Today, upstream MLPs are looking healthier after cutting distributions and making meaningful reductions in spending plans for 2015. Capital preservation is the main theme. The passage of the spring redetermination period also lifts a material overhang on the group in general. Everyone has sobered up mighty quick in light of reduced oil prices. The outlook for distributions and spending profiles is far more sustainable than what it looked like going into 2015, which goes a long way to reducing risk compared to levels seen in late December and early January.