29 September 2016
In a surprising move, OPEC member states have agreed to freeze or slightly reduce their oil output. The details, including production quotas for each member, still need to be negotiated and will be announced at the next official OPEC meeting at the end of November.
If we assume that OPEC will be able to iron out the remaining hurdles, this is a clear positive for the oil price. While the quantitative impact on the supply/demand situation is limited, it sends a clear message: after deliberately flooding the market for two years with the intention to flush high-cost producers out of the market, the oil cartel is returning to its role of oil price stabiliser. This will put a floor to the oil price, as fears of a further increase of OPEC output are diminishing.
Our outlook for the oil market does not change materially following this decision. We expected the market to shift to a supply deficit sometime in 2017, and with an OPEC production freeze this scenario is brought forward by a few months.
The medium-term fundamental development in the sector is the key to our view: Oil and gas producers have cut investments by an unprecedented amount over the last two-three years, new project approvals have come to a standstill and new oil discoveries are at a 70-year low. For the majority of oil producers, with the exception of US shale oil, these supply capacity curtailments will only start to have an impact in 2017. Crucially, they can’t be reversed over the next three-four years. Oil markets are therefore likely to find themselves in a tight supply situation for an extended period. Oil prices over time will have to rise to a level that incentivises producers to invest again. For the majority of producers this threshold will be reached at oil prices between USD 60 and 70.
Energy equities are currently the most underowned and undervalued sector relative to historical averages. We view low-cost North American shale oil and gas producers with above-average production growth as the main beneficiaries of higher oil prices. Selective oil and gas service providers are the first to benefit from a recovery of investment activity. Meanwhile, the policy support and cost competitiveness of renewables have never been more favourable than today.
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