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Morningstar projects 'pain for oil prices' later in 2018 from US shale flood

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Morningstar projects 'pain for oil prices' later in 2018 from US shale flood

Oil prices have surged to their highest levels in several years, but at least one investment firm is saying U.S. shale producers will force prices lower in the second half of 2018.

In its third-quarter market outlook, Morningstar Inc. said a shale surge remains likely and has the firm sticking to a mid-cycle forecast of $55 per barrel for West Texas Intermediate crude oil. Morningstar said it believes U.S. producers are capable of wiping out price-raising shortfalls caused by a lack of production from Venezuela and Iran on the market, as well as other production curtailments from OPEC members.

"We believe the market continues to underestimate the capacity of the shale industry to throw oil markets back into oversupply," analyst Joe Gemino said. Prices in excess of $65/bbl for much of 2018 have been attractive to shale producers, who have break-even prices well below that level. As a result, rig counts have surged above 650 and production is climbing in major areas, including the Permian Basin and Eagle Ford Shale.

Morningstar did note the pipeline shortfall in the Permian, saying it could slow down the "reckoning" for higher prices. Production should overwhelm the market and knock prices back down, the analysts said.

"Eventually, we expect pain for oil prices as growing U.S. production serves as the primary weight to tip oil markets back into oversupply," Gemino said. Bucking speculation that prices could shoot above $100/bbl in the near future, Morningstar said "the industry hasn't recognized the danger" of a significant increase in U.S. unconventional production.

"Because of the long lag between adding rigs and seeing a production response, the impact of the most recent additions hasn't been felt yet. And to make matters worse, temporary equipment bottlenecks and labor shortages are still slowing completions and masking shale's growth potential. … When these are resolved, the shale industry will find itself rapidly overheating unless producers start slowing down, and only a drop in oil prices can persuade them to do that," Gemino said.