Paul Sankey: Oil Would Be Below $60 If It Weren’t For Saudi Production Cuts

Episode Summary

Executive Summary: Paul Sankey argued oil is currently in equilibrium around $80 Brent, supported by Saudi supply restraint, while U.S. production growth slows from last year’s surge. He sees oil prices as range-bound and supportive of big-cap energy cash returns, but remains bearish natural gas and service stocks. He also highlighted AI as a major new driver of power and gas demand, especially through data centers.

Main Topics: Oil market equilibrium and Brent outlook (Priority: 5/5): Sankey said oil is balanced near $80 Brent, with Saudi Arabia acting as the key swing producer. He sees limited upside unless supply tightens materially, and limited downside while Saudi withholds capacity. Saudi Arabia as the 'central bank of oil' (Priority: 5/5): Saudi production cuts are stabilizing the market, but the kingdom still has large spare capacity and could either defend prices or shock the market if it decides to flood supply. U.S. oil production growth slowing (Priority: 5/5): U.S. production hit record levels last year and was a major bearish force, but Sankey expects growth to slow sharply this year and potentially flatten in 2025 as capital discipline improves. M&A and consolidation in U.S. E&P (Priority: 4/5): He views the consolidation wave as rational and shareholder-friendly for large-cap acquirers like Exxon, Chevron, and Diamondback, though low takeover premiums have left many smaller shareholders unrewarded. Investment case for big oil vs. weak gas and services (Priority: 4/5): Sankey prefers large integrated producers and midstream pipelines, while remaining negative on natural gas and service companies due to weak gas prices and needed supply cuts. AI-driven electricity demand and natural gas (Priority: 4/5): He argued AI/data centers are materially increasing power demand, especially in Virginia and Texas, which should boost natural gas demand as the needed backup to intermittent renewables.

Key Arguments: Oil is near equilibrium at about $80 Brent because Saudi cuts have offset U.S. supply growth and seasonal refinery weakness. Saudi Arabia has enough spare capacity to cap oil upside, but its willingness to defend prices creates a floor under the market. U.S. oil output grew by about 1.5 million barrels/day last year but likely slows to around 0.5 million barrels/day this year, easing bearish pressure. Big oil is generating record cash returns, with dividends and buybacks approaching roughly 10% annually, making the sector attractive for long-term investors. Natural gas is weak because warmer/normal winter demand and oil-linked U.S. drilling have created oversupply. Midstream pipeline businesses benefit from record U.S. volumes even when upstream growth slows, making them a favored segment. The current M&A cycle reflects a quality and inventory premium: best-run companies with deep inventory in the Permian and Guyana deserve higher multiples. Low takeover premiums mean shareholders of weaker E&Ps may not be adequately compensated, especially when CEOs capture change-of-control payouts. AI is a significant new load driver for electricity demand; data centers and NVIDIA chips imply far more gas-fired power generation will be needed. The U.S. oil industry is strategically important because it transformed the country from a major importer into a net exporter, strengthening the economy and geopolitics.

Data Points: Brent oil price equilibrium: About $80/bbl - Sankey’s estimate of the current balanced market price Saudi production: About 9 million barrels/day - Current Saudi output while supporting prices Saudi observed capacity: 11.8 million barrels/day - Capacity estimate referenced, including peak during COVID Saudi spare capacity reduction: About 1 million barrels/day cut - Used to keep the market in equilibrium Exxon/Chevron/BP/Total/Shell/Conoco returns: Approaching 10% annually - Dividend plus cash returns described as record-level U.S. oil production growth last year: About 1.5 million barrels/day - Stated as an extraordinary increase that outpaced global demand growth Expected U.S. oil production growth this year: About 0.5 million barrels/day - Forecast for slower growth in 2024 Global oil demand growth: Over 1 million barrels/day in a strong year - Benchmark used to compare U.S. supply growth U.S. oil imports in 2008: About 13 million barrels/day - Historical import dependence before shale boom Current U.S. net oil exports: About 2 million barrels/day - Illustrates the shift in U.S. energy balance U.S. LNG exports: From 0 in 2016 to largest exporter in the world - Used to illustrate broader U.S. energy transformation Gasoline price risk to consumers: 25% to 30% above current levels / over $4 nationwide - Threshold Sankey said could trigger broader consumer pain NVIDIA chip power use: 700 watts per chip - Used to illustrate AI’s power intensity Virginia power demand forecast change: Quintupled - Dominion revised expectations upward due to data centers Potential new gas-fired power in Virginia: Up to 9 gigawatts - Estimated additional natural gas generation needed Oil sector share of S&P earnings: About 7% to 8% - Compared with market-cap share Oil sector share of S&P market cap: About 3% to 4% - Argued to show undervaluation relative to earnings Diamondback scale: 80,000 bpd in 2017 to 800,000 bpd - Example of rapid growth via consolidation and scale Change in share count at Marathon Petroleum/Marathon Oil: Down more than 20% over 2-3 years - Cited as tangible shareholder return through buybacks XLE ETF valuation ceiling: Never above 100 - Used to argue oil equities won’t capitalize a major oil spike Saudi budget balance price: Around $80/bbl - Price level that roughly balances Saudi public finances Saudi preferred oil price: About $95/bbl - Aspiration level for stronger fiscal surplus Merger-arb example on Hess/Chevron: About 20% return cited by arb shops - Spread discussed as reward for deal completion risk

Pivotal Quotes: "At the moment, Saudi is very responsibly acting as the central bank of oil." — Paul Sankey: Describing why Brent is holding near equilibrium despite weak seasonal demand "We like all the deals... the biggest companies with the best inventory are getting the best multiples." — Paul Sankey: Summing up his positive view of consolidation and large-cap acquirers "What really caught my eye is Dominion's electricity demand forecast for Virginia... essentially quintupled their electricity demand forecast." — Paul Sankey: Explaining how AI/data centers are changing power demand assumptions

Implications: Oil may stay range-bound near current levels, favoring large-cap producers and midstream names over service firms and weaker E&Ps. AI could materially lift gas and power demand, making electricity infrastructure and natural gas supply more important over the next several years.