Will the oil price improve in 2017 (and beyond)?

 You may have seen the news last week that OPEC (Organisation of the Petroleum Exporting Countries) members have agreed to reduce their oil production for at least the first six months of 2017. Unexpectedly, non-OPEC oil producers such as Russia have also agreed to lower targets. So will this mean a higher oil price in 2017?

The proposed cuts, which are the first since 2008/2009, aim to drive down global supply and push up demand. The agreement will see most OPEC members knock around 5% off production levels, including Saudi Arabia – easily the biggest producer of the bunch and the one that has been most reluctant to reach an agreement over the past two years of tumbling prices.

However, despite its powerful position as a large-scale exporter, Saudi Arabia's economy is also starting to feel the pinch, and we may now have reached a point where the country finally believes it is in its best interests to support price action. Saudi is running an enormous fiscal deficit and was recently forced to cut ministerial salaries and allowances. A higher oil price would once again increase government revenues and help to alleviate budget concerns. What's more, the state-owned Saudi Aramco (the world's biggest oil company) has plans to list on the stock exchange and a higher oil price wouldn't go astray on this front.

Another key determinant of success is whether non-OPEC members like Russia (and other potential participants like Kazakhstan and Mexico) will also stick to the agreement. In the past, Russia has not always done so. Having said that, OPEC have taken the unusual step of setting up a 'Ministerial Monitoring Committee' of both OPEC and non-OPEC members to oversee compliance. This shows a strong intention, at least, of all countries meeting targets.

So the near-term to mid-term outlook for oil as we head into 2017 is more positive than it's been in a while. Prices certainly moved higher immediately after the announcement and, at the time of writing, the oil price per barrel was up above US$55 for the first time in 20161.

For those that have an ongoing investment interest in the commodity however—as I myself do—the bigger question is arguably around the future of oil itself, rather than simply talking price trends.

We've been talking about this a lot in the office of late and, within our research team, we have quite a mix of views – and they're mostly to do with the future of electric cars. 55% of all oil demand comes from transportation2, so the uptake of these vehicles could make a big difference to the oil outlook in the coming years.


Positive on electric cars

James Yardley, our oil bear and Chelsea's senior research analyst, essentially believes the commodity's future is limited because of the looming boom in electric vehicles. He summarises his arguments as follows:

  • The oil industry is in denial in the face of disruptive technology. James believes the oil industry is basing future demand predictions on past population and GDP growth indicators, but he thinks the electric car will alter demand levels significantly
  • Improvements in battery technology are making electric cars rapidly more popular and practical (batteries are becoming cheaper and the charge lasts longer)
  • It's not just Tesla. More and more car companies are getting in on the act, exploring ways to bring affordable electric cars to market
  • Environmentally, electric cars have the clear advantage. As carbon emissions reduction targets become the norm in both developed and developing nations, gas guzzling cars surely will go by the wayside


But a long way to go yet?

Ryan Lightfoot-Brown, another of our research analysts, sees a more solid medium-term oil outlook for investors. His core thoughts are:

  • It is more a case of 'evolution' not 'revolution' where the oil industry is concerned. He agrees electric cars are ultimately the future, but believes the uptake will be slower than James anticipates. A core reason for this centres around infrastructure
  • In cities, people's homes are hardly set up for charging cars. Do we install charging points on cluttered pavements? How many people can use them simultaneously? How convenient will they be? 
  • Outside of the city, motorways cover great distances, with simply a few fuel stations dotted along the way. Stopping to fill up with petrol for the next leg of your journey takes about five minutes before you're back on the road; charging a car could be a lot longer wait
  • These challenges can of course be overcome, but the speed with which this level of new infrastructure can be implemented is unclear. Londoners will be familiar with projects such as Heathrow Airport's third runway and the High Speed 2 railway, both of which have been in discussion for years and are still some time away from becoming reality
  • Let's not forget, transport is not the only method of oil consumption. It is also used to produce materials and products such as plastics, rubber, drugs, pens – demand for all of which is likely to grow in both emerging and developed markets in the coming years.


Energy equities in the year ahead

Speaking with the people behind the Guinness Global Energy fund last week, I was given an oil price 'desired level' of around US$70 a barrel. They described this as the “happy medium” where OPEC economics would be better satisfied, the world economy could be stable and US oil production could grow in a controlled manner.

In terms of energy equities, they commented that the price-to-book valuation of energy equities versus the broader American stock market (the S&P 500) is close to 65-year lows3. So they believe there could be good potential to turn a profit in energy equities right now, if the oil price does rise and energy companies' stock prices rise along with it.

Of course, it's important to remember nothing is certain and the oil outlook could change at any time. As always and as with any investments, you could lose or make money by investing. 

By Darius McDermott, managing director, Chelsea

 

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius's views are his own and do not constitute financial advice.
1Bloomberg Brent Crude price chart, 31/12/2015–05/12/2016, accessed 05/12/2016
2http://www.businessinsider.com/electric-vehicles-a-problem-for-big-oil-2016-10?IR=T
3Guinness Global Energy figures and commentary, provided 01/12/2016
Published on 05/12/2016