The oil price has changed for a generation

Chris Taylor, Investment director and head of Research at Neptune Investment Management, explains why he believes sub-$50 oil could be the norm for investors for the next decade or two.

The oil price has more than halved over the past 18 months. Many market participants assume this is a temporary phenomenon.

We believe they are wrong. Our analysis of the changes taking place in the real world suggests the oil industry is adapting to life with an oil price that will not return to its old equilibrium for a decade or two. This is the result of a massive but largely unheralded improvement in shale resource extraction techniques.

For most, both in government and on the sell side, the long-term historical marginal cost of oil production – estimated by the World Bank to be between $80 and $90 per barrel globally – is still thought of as the long-term equilibrium price for oil going forward.

Our view is that it could in fact be less than half that. This is principally because the old estimation of the industry-wide average break-even point was heavily dependent upon the belief that deepwater – or at least offshore – extraction would be increasingly necessary to meet global demand.

The emergence of US shale though has changed this. Indeed the largest shale basins – such as Bakken, Permian and Eagle Ford – now boast radically lower costs.

The evidence suggests these fields have enough untapped potential to meet the needs of the industry in the years ahead at a new, much lower break-even price of around $36 per barrel.

What is most astonishing about these oil fields is the sheer pace at which their productivity is still improving, which more than compensates for the declines in rig counts that have occurred in recent months (a measure the sell side remains fixated on to account for supply-side factors).

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