Core Laboratories (NYSE:CLB) is unabashedly bullish on its prospects. After a challenging past couple of years, the company expects a reversal of fortunes in the oil market this year, going so far as to predict that a "V-shaped" recovery would start taking hold that would drive its financial results higher as well. Fueling that forecast was Core's belief that the oil supplies were falling at such a rapid rate due to underinvestment that the market would soon become vastly undersupplied. That gap between supply and demand should push prices higher, which would drive a rebound in drilling activities.

That said, while Core Labs makes a compelling case, there is one thing that could derail its recovery: an unexpectedly fierce rebound in U.S. shale production. Here's a look at how that might cause Core's recovery to fizzle out. 

An oil pump jack next to an oil worker and a laptop.

Image source: Getty Images.

Drilling into the data

In Core's first-quarter report, the company gave its regular update on the oil market. It noted that from July to December of last year that worldwide oil inventories fell by an average of 770,000 barrels per day due to underinvestment in new supplies by oil companies. Furthermore, it pointed out that starting in January, OPEC and cooperating non-members would cut their supplies by more than 1.3 million barrels per day. Add it up and Core anticipated that the market's undersupply could be more than 2 million barrels per day this year. As a result, Core expected that "the continued under-supply of crude oil should lead to extended worldwide inventory declines and a continuing rally in energy prices throughout 2017."

However, more recent data from the International Energy Administration (IEA) showed quite the opposite occurring. In its June report, the IEA said that oil stockpiles ballooned by 18.6 million barrels, which pushed them 292 million barrels above the five-year average and higher than they were when OPEC announced its output cut. Fueling the oversupply was the fact that demand growth has been slower than expected at just 900,000 barrels per day, which is below the forecast of 1.3 million barrels per day. Meanwhile, supplies were up 1.25 million barrels per day in May, which was the highest annualized increase since February 2016. That surge in output was due to rising U.S. shale production as well as higher output from OPEC as a result of surging production from Libya and Nigeria, which are exempt from the OPEC output cuts. These factors have the potential to keep an oil market recovery at bay, especially if shale drilling continues to outpace expectations.  

Oil workers on a rig.

Image source: Getty Images.

Coming back with a vengeance

Shale producers have already unleashed an unexpectedly massive gusher of new oil production this year. According to the U.S. Energy Information Administration (EIA), America's oil production averaged 9.3 million barrels per day at the end of June, up 910,000 barrels a day from the year-ago period. More production growth is on the way according to the EIA's latest short-term forecast that the U.S. oil output will average 10 million barrels a day next year, which in its view could drive global oil inventories higher over the next year.

One of the drivers of this growth is the fact that shale drillers are producing more oil for less money. For example, Permian Basin-focused driller Parsley Energy (NYSE:PE) expected to increase output by 70% this year to a range of 62,000-68,000 barrels of oil equivalent per day (BOE/d) due to a combination of several acquisitions last year and organic drilling in 2017. However, thanks to better-than-expected well results in the first quarter, Parsley Energy increased its full-year production guidance by roughly 3,000 BOE/d or nearly 5% at the midpoint, without increasing its budget.

Leading shale driller Devon Energy (NYSE:DVN), likewise, delivered expectation-beating first-quarter output. In fact, Devon Energy's oil production exceeded the top end of its guidance range by 5,000 barrels per day thanks to better-than-expected well results. That kept Devon on track to deliver on its plan to boost output 13% to 17% by year-end.

Because shale drillers are producing more oil per well, it's putting downward pressure on oil prices. Those lower prices could cause drillers, especially those with weaker balance sheets, to complete fewer wells this year. That situation could cause the industry to hit the brakes on drilling activities, which could impact the "V-shaped" recovery that Core Labs envisions for its financial results.

Investor takeaway

Core Labs firmly believes that the downturn in the oil industry and its financial performance are in the rearview mirror due to its perception that robust demand growth, when combined with falling supplies, will leave the industry undersupplied this year. While I believe its view is the right one, it isn't a slam dunk because shale drillers are producing more oil than anticipated due to a significant improvement in well productivity. If that trend keeps up, it's possible that Core's recovery could turn into a "W" instead of the "V" that bullish investors like me had hoped. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.