9.23.16:Why Oil Prices Can’t Stay Low For Much Longer

Oil Rigs

For many oil companies, the current downturn in oil is a back-breaker, but some have adapted to the falling prices and are fighting each day to survive and benefit from the higher oil prices that lay at the end of this dark tunnel.

In order to understand the prevailing glut, we have to go back more than a decade when investments into the oil and gas sector began to soar.

As seen in the chart above, the investments have multiplied from their lower levels to about $780 billion in 2014. The rise has been steady throughout, with the only dip coming in 2009. Such huge investments in a single decade resulted in the global oil supply increasing by 13 percent. During the same period, OPEC’s supply increased by 21.6 percent.

The massive amount of money being pumped into the oil and gas sector was due to the impressive gains in crude oil during that period. According to an analysis by the Zephirin group; between 2003 to 2013, WTI prices increased by 215.3 percent, whereas, Brent rallied by 276.3 percent.

However, demand failed to catch up with the breakneck speed at which oil was being pumped into the market. This ended with a massive oil glut, which has led to the worst oil crisis in decades.

There are a number of optimistic voices that point to a steep fall in investments from $780 billion to $450 billion in the past two years. They believe that soon the glut will shift to a deficit due to fewer oil discoveries and aging wells, which will boost prices higher.

“There is evidence that cuts in exploration activities have already resulted in a dramatic decline in new oil discoveries, dropping to levels not seen in the last 60 years,” said the IEA’s World Energy Investment 2016 report, reports The Telegraph.

However, a study by RBC Capital Markets expects new non-OPEC production of 2.16 million barrels a day to come online this year. In 2017, they expect an addition of 1.24 million barrels a day and for 2018, the figure is 1.58 million barrels a day. In 2019 and 2020, the additions are expected to subside to 680,000 barrels a day and 480,000 barrels a day respectively, reports The Financial Post.

With demand growth not looking very encouraging, the Zephirin Group’s Longdley Zephirin believes that the oil market “needs to collapse before it can improve,” reports Barron’s.

However, does it mean that the investors should shy away from the oil and gas stocks? Not really.

“Based on a simple calculation, HSBC estimates that by 2040, the world will need to find around 40 million barrels of oil per day to keep up with growing demand from emerging economies,” reports Business Insider.

This means that companies that manage to survive this downturn will have decades of high oil prices to benefit from. There are a number of companies that are cutting costs, innovating, building relationships with clients and hedging smartly. Such companies will be the ones to survive the downturn, emerging stronger to reap the benefits of high oil prices when the cycle turns again.

Investors should therefore be on the lookout to invest in companies that have a strong balance sheet and are offered at reasonable prices, because oil prices will not languish at the current depressed levels forever.

By Rakesh Upadhyay for Oilprice.com