Banks are Increasing Price Decks

Given the last month’s increased hydrocarbon prices (approximately +18% for gas and +11% for oil), banks are increasing their price decks for evaluating loans to E&P companies.  In a recent Wells Fargo Securities Equity Research Report1, the table below shows their current oil price decks for both WTI and Brent.  This reflects about an $8.00 per barrel increase in the first quarter of 2018 and a $3.25 increase for 2018 overall.

The price deck used to evaluate oil and gas drilling, combined with drilling costs, lease operating expenses and present value factors are the key determinants of the value of an oil and gas property/company and the corresponding collateral value for a bank loan.

Wells Fargo’s report attributes oil’s recent outperformance to a number of factors, including OPEC production cut compliance, declining inventories, multiple minor supply disruptions, favorable weather, and an improved global economic performance and outlook.  Therefore, the bank has adjusted their oil price deck upward to reflect:

  • improved inventories,
  • the stronger demand trend, and
  • a modest expected improvement in E&P capital investment discipline.

Even though Wells Fargo increased its price decks for the long-term, they do have a bearish outlook on 2018 with a quarterly reduction from $58.00 in Q1 to $53.25 by year-end.  This equates to an expected one standard deviation reduction in oil prices by year-end.

Crude Oil Outlook

While futures markets aren’t a crystal ball, their price levels and related options are useful for estimating future ranges, or “confidence intervals,” for crude oil and natural gas prices.

The graphic below shows crude oil price as of January 16, 2018 and predicted crude oil prices based on options on oil futures contracts (ticker /CL).

On the graphic below, the blue lines are within one standard deviation (σ) of the settlement price (green line) and the red lines are within two standard deviations for each month (for a refresher on standard deviations, see the January 2016 blog).

Based on January 16, 2018 pricing, the futures markets indicate that in mid-May 2018 the expected price is $63.17 with a 68% chance that oil prices will be between $55.50 and $71.00 per barrel. Likewise, there is about a 95% chance that prices will be between $46.00 and $83.00.  For a longer-term view, by mid-November 2018 the +/- one standard deviation price range is between $49.50 to $63.00 per barrel with an expected value of $60.75.

Natural Gas Outlook

We can do the same thing for natural gas futures, currently trading at $3.09 per MMBtu on the Henry Hub (ticker /NG).  Although more affected by seasonal factors than crude oil, in March 2018, the expected price is $2.91 with a +/- 1σ price range of $2.35 to $3.15 per MMBtu, and the 2σ range (95%) of $2.05 to $3.85 per MMBtu.  For a longer-term view, by mid-May 2018 the expected price is $2.75 per MMBtu with a +/- one standard deviation price range is between $2.35 to $3.25 per MMBtu.

1. Wells Fargo: “Oil Macro: How Much Good News Is Priced In?,” January 11, 2018

Tags: Oil & Gas Price Outlook January 2018, Gas Price Outlook January 2018, Oil Price Outlook January 2018

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