I’ve talked quite a bit about the self-defeating dynamic that’s ensnared US oil production.
As prices collapsed (and even before) shale oil had a free cash flow problem – namely, there wasn’t any. Free cash flow that is. That meant capital markets had to plug companies’ funding gaps. As Citi put in back in 2015, “easy access to capital was the essential ‘fuel’ of the shale revolution. But too much capital led to too much oil production, and prices crashed.”
Since the collapse in prices, producers have been kept afloat by the same easy access (or if it’s no longer “easy” it’s still “access”) to capital. The source of that capital has evolved as you’d expect for a sector that by all rights should probably be out of business. When the debt markets slammed shut and the revolvers were cut, companies tapped the equity markets via follow-ons. They survived (or at least some of them did) to pump another day.
Well that day has now come with prices higher on the OPEC/non-OPEC production cut deal. The problem though, is the same as it always was: pumping more just ensures that prices will eventually fall again. Only next time, it’s not clear whether capital markets will be open and even if they are, higher rates will raise the cost of borrowing.
The paradox: higher prices ultimately lead to lower prices.
With that in mind, consider the following excerpts from a Goldman piece (out Tuesday) outlining the effect of a new tax regime (under Trump) on crude. One key point is the idea that destination-based taxation will push WTI to a premium over Brent. Can you guess what happens next? Here’s Goldman:
Destination-based tax while unlikely could push WTI above Brent… While our economists see this as a low probability event (20% likelihood), in a scenario of a destination-based tax with border adjustment (DBTBA) and a corporate tax rate of 20%, we expect WTI could move to a $10/bbl premium to Brent from a $3 discount – a $13/bbl (+25%) relative move immediately.
The medium-term impact to absolute oil prices would depend on how quickly US production reacts to higher prices vs. how quickly the rest of the world reacts to make space for higher US production. If 2017-18 WTI oil prices move to $68/bbl ($13 premium to 2018 forecast), our analysis implies the incremental investment could result in 1.5 mn bpd of 2018 US oil growth (vs. 0.8 mn bpd at $55 oil). Unless OPEC cuts further, this could oversupply global oil markets and potentially lead to another oil boom-bust cycle.
For those interested, below is an infographic from Goldman that purports to document the impact a destination-based tax with border adjustment regime would have on oil and thus, on the economy.