The case for higher oil prices seems watertight. Global demand growth, fed by rising populations and incomes in developing countries, isn’t going away. But the lion’s share of the expanded supply gains delivered in recent years by U.S. drillers is not going to stick around at $55 a barrel, because there’s little appetite at that price to keep drilling in order to offset the rapid decline rates of shale wells.

It’s a nice theory, and the only problem is that so many market participants are already heavily invested in it.

Start with the owners of the record 489 million barrels of crude commercially stored in the U.S., part of a global glut now evident in the more than a billion barrels stored across the developed world. The owners of all that unconsumed crude are counting on higher prices to recoup their storage costs.

Proceed to the drillers sitting on several thousand uncompleted U.S. oil wells, who’ve built up this “fracklog” so as to bring the wells online later at higher crude prices.

Consider also the expectations of investors who’ve bid the stocks of those drillers back to levels that prevailed in October and November, when crude prices were materially higher. They too are counting on significantly higher oil prices to prolong the rally.


Ditto for the subset of the bullish mob that’s invested more than $10 billion so far this year in secondary equity offerings by oil drillers. And of course the debt buyers who’ve sunk nearly $6 billion year-to-date into producer bonds share the sentiment, as do the institutional investors who so far in 2015 have committed some $14 billion to private equity funds searching specifically for  bargains in the energy sector.

If all those people are quickly proven right, it may mark the first time ever so popular a trade has paid off as expected.

Color me skeptical, if only because a lot of the money pouring into energy investments doesn’t seem particularly smart. What it obviously is, is easy.

 “There’s a lot of cheap money out there chasing deals right now,” noted Kinder Morgan (NYSE: KMI) CEO Rich Kinder Monday, in explaining the dearth of distressed midstream deals.

The week before, it was the turn of Blackstone (NYSE: BX) Chief Operating Officer Tony James to explain why the leading private equity firm hasn’t found as many opportunities as hoped in energy. The drillers that might otherwise have needed its money have “been all able to go out and raise a lot of debt, and in some cases equity publicly, at values or at interest rates we wouldn’t have touched,” he said. 


Blackstone is smart money, and it’s largely stayed away. So has Kelcy Warren, the savvy dealmaker in charge of Energy Transfer Equity (NYSE: ETE) who said in February he was disappointed by the “temporary” rebound in oil prices because it has postponed the time of reckoning, when he hopes to pounce.

This week, at the big energy conference in Houston, ExxonMobil (NYSE: XOM) CEO Rex Tillerson predicted oil prices will stay low for the next few years. So did his counterpart at BP (NYSE: BP). They’re not calling for $30 a barrel, but obviously don’t see much near-term upside from the current $57/bbl.

For crude to keep rising from here, the excess of supply responsible for all those record barrels in storage would have to start to dissipate. Demand growth would need to start to catch up with supply despite the economic downturns in China, South America, Africa, Russia and the Mideast, which were collectively responsible for the bulk of increases in global fuel consumption over the last decade.

Supply would need to moderate despite all the additional money that’s been pouring into shale drilling, despite the hefty discounts the industry is extracting from its own suppliers, and the continuing technological advances that are also continuously lowering production costs.

The increased oil price would then need to withstand the effect of many of the currently uncompleted wells getting fracked post-haste and of the owners of stored crude looking to book their profits.

A lot of things would need to go right for crude bulls rather quickly for them to sell out at a profit to the strategic buyers who are still biding their time and counting on a fire sale.

It would mark that rare occasion when production of a commodity was effectively curtailed without knocking the weakest marginal producers out of business.

While certainly conceivable, it’s not our base case. We continue to emphasize strong midstream and downstream businesses that stand to profit from improved domestic energy demand. While perhaps not as sexy as some of the shale drillers down on their luck, they are much likelier to emerge as long-term winners.