A distinct shift leaves oil lower … for longer

The price of energy and oil, more specifically, is so heavily determined by shorter-term, cyclical factors that constructing an actionable longer-term view is challengin

Despite that, a number of influencing factors are likely to endure for some time: further enhancements to drilling technology, continued environmental pressure, and increased development and refinement of alternative energy sources.

The price of oil has dropped by more than half since early 2014, yet supply continues to be near its all-time high. Recent estimates show that global demand, despite growth this year to 1.7 million barrels per day (mb/d), is unlikely to sustain that pace next year. Supply still exceeds demand, and correcting this imbalance is essential to firmer oil prices.

Our short-term forecast is for the WTI benchmark to average just under US$50/barrel this year, and rise to an average of US$57 next year. It’s our view that if the price of oil settled anywhere under $60/barrel, it would seriously constrain new projects in the United States, and continue to slow output growth in Canada and elsewhere.

While global demand isn’t likely to increase as fast as it had during the past decade or so, due to moderating growth in emerging markets, and the ascent (if still small share) of alternative fuels, it will still be growing for at least another decade, as new projects are needed.

The risk to a $57/barrel forecast is likely skewed to the downside, given challenges to more robust global economic growth. Looking beyond 2016, the global market is likely to remain in an excess demand condition (compared to surplus supply this year, and likely through the first half of next year), leading to a further paring of excess global inventories and a moderate rise in prices.

What has happened over the past year has led to a major change in oil company strategy and investor preference — from investing to expand oil production at any cost (oil prices over $95/barrel are a huge incentive) to investing to optimise profitability. Improvements in capital and operating efficiency will at the same time reduce production growth, costs and equilibrium prices.

Steven Bell – Multi-strategy Team – BMO Global Asset Management