Is now the time to invest in oil?

Market insights

After two years of oversupply, the world is swimming in hydrocarbons and oil prices are depressed. In this insight, we explore supply trends across the US and OPEC and find that despite the increase in oil inventory levels over the past two years, the scene is set for a rise in oil.


Why prices have fallen in recent years

In November 2014, OPEC decided not to cut oil production in response to excess market supply. To further exacerbate the issue, US oil inventories are at all-time highs. Sanctions previously restricting the supply of oil from Iran have also been lifted, causing an influx of supply into the market. The result was a significant fall in the price of oil in recent years. While the oil price has risen recently, they remain very low.


Chart 1. Brent Crude oil price (US$)

Australian Equity Dividend Yield versus Bond Yield

Source: IRESS


Three key reasons why we believe the oil price will continue to rise.

1. Demand is solid

Over the past 30 years demand for oil has increased by approximately 1.5% year on year. As developing countries such as India continue to modernise, we expect demand growth to remain steady. Lower prices have also provided a tailwind for demand.


2. OPEC production growth has slowed

OPEC accounts for 41% of oil production globally. Over the past two years, OPEC (in particular Saudi Arabia, Iraq and Iran) has materially accelerated oil production. However, there is evidence to suggest that while OPEC has not officially implemented a freeze, production growth has slowed materially in recent months. For example, Chart 2 highlights that the number of oil rigs operating in in Saudi Arabia has stopped growing.


Chart 2. Saudi Arabia oil rig count

Bank Payout Ratios

Source: MIMGL


3. The rest of the world has reduced supply in response to lower prices

Our research suggests that significant global oil producers such as the US will struggle to grow oil supply materially at prices below US$50 per barrel. These lower oil prices combined with higher debt levels have seen investment in non-conventional oil production in the US become much less attractive. Global and regional investment in oil exploration and production during 2015 and 2016 has decreased. This is significant for global supply as oil requires continued investment of capital to maintain production levels.


Conclusion

After two years of oversupply, OPEC production growth is stagnant and oil supply from the rest of the world (ex-OPEC) is in decline. Despite inventory levels at all-time highs, without further investment in supply, we believe there will be a global shortage in oil over the next few years.

According to our research, the world will be short oil in 2017. To meet this increase in demand, investment in oil production and exploration must start NOW. At current price levels, we believe energy companies will struggle to invest in time to meet demand. Over the short-term, supply will be tight. Setting the scene for a rise in the price of oil!

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