Earlier this month, the U.S. Energy Information Administration (EIA), the U.S. government agency in charge of collecting, analyzing, and disseminating energy-related data, put out its latest short-term energy outlook (STEO). In that report, the EIA trimmed its 2017 oil price forecast and cut its expectations for oil production growth this year and next, seemingly throwing cold water on a near-term recovery in the oil market.
But one oil CEO, Harold Hamm of Continental Resources (CLR +0.00%), took it to task, saying he thought the report was so far off that it's distorting oil prices. He thinks the EIA isn't taking into account the discipline that shale drillers are showing these days, which should result in much less production growth over the next year than the EIA anticipates. That lower projected output, should, in theory, lead to higher oil prices and more profits flowing into Continental's coffers.
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Drilling down into the disagreement
The EIA's STEO predicts that oil production in the U.S. will average 9.3 million barrels per day this year before rising to an average of 9.8 million per day next year. That would set a new record for oil output in the country, surpassing the 9.6 million barrel-a-day annual average set in 1970. However, what's noteworthy about that forecast is that the numbers represent declines of 1% and 0.7%, respectively, from the EIA's prior outlook.
Driving the decline is that many shale drillers have recently announced budget cuts that will slow their growth rate. For example, Bakken-focused shale driller Whiting Petroleum (WLL +0.00%) initially expected to spend $1.1 billion drilling and completing wells this year, which would boost its output 23% by the end of this year compared with where it ended last year. But after crude spent most of the early part of the year in the $40s, Whiting Petroleum decided to cut $150 million from its budget last quarter and drop two drilling rigs to help balance its budget after initially assuming oil would be in the mid-$50s. As a result, its exit-to-exit growth rate will now only be 14%. Meanwhile, Permian Basin powerhouse Pioneer Natural Resources (PXD +0.00%) ran into some drilling problems last quarter, which put it behind schedule. However, instead of reaccelerating, Pioneer decided to defer those wells into next year, given the weaker-than-expected oil market. As a result, Pioneer cut $100 million from its budget and now expects production growth to be at the low end of its expected 15% to 18% range.
While the EIA did reduce its forecast to reflect these and other reductions, Hamm doesn't think it went far enough. In his view, production in the U.S. will rise by half of what the EIA expects. He recently told Bloomberg that the "exaggerated amount that EIA has out there" is contributing to the market's oversupply worries, which is keeping a lid on oil prices. He thinks that if the EIA wasn't distorting the market by overestimating production growth, crude would rise to $60 a barrel.
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He has a point, but he shouldn't talk, either
Hamm isn't the first one to criticize the government's ability to forecast. While the energy markets are notoriously challenging to accurately predict, the EIA has an abysmal track record. In fact, according to the EIA's retrospective review of its forecasts, which it did to contend with the critics, it found that it overestimated oil production 43.2% of the time and was off by an average of 11.9%.
Given that poor track record, Hamm could be right. However, it's also worth noting that his track record for predicting the oil market is just as dismal. In late 2014, for example, he made a bold bet that OPEC would blink and cut its output before prices fell any further. That gamble blew up when OPEC not only didn't blink but also went for shale's jugular by ramping up its output. Meanwhile, in 2016 he thought crude would be $69 to $72 by the end the year, which of course didn't happen.
It's also worth noting that Hamm's company isn't demonstrating much discipline. Instead of hitting the brakes, Continental now expects to end the year producing 24% to 31% more than the end of last year, up from an initial outlook of 19% to 24% growth. Furthermore, his company is on pace to deliver another 18% increase in output next year.
The pot calling the kettle black
Hamm might be right that the EIA is too optimistic on 2018's production numbers. It certainly wouldn't be the first time the government agency's cloudy crystal ball malfunctioned. But Hamm doesn't exactly have a sparkling track record when it comes to making predictions either, which has hurt investors in his company.
Still, Hamm's contention with the forecast brings up a good reminder for investors, which is that they shouldn't take energy market predictions too seriously because, more often than not, they're wrong. They should instead focus their attention on investing in oil stocks with a low-cost resource base and a top-tier balance sheet, because these companies can thrive even if future forecasts turn out to be wrong.
