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Oil Supply Falling Behind Demand

The International Energy Agency last week highlighted growing risks to the oil supply as a result of underinvestment. Roberto Cominotto, investment director for energy equities at GAM, considers the possible implications for the global oil market.

Thursday, March 16, 2017

Oil traders getting impatient with slow US inventory draws

A faster than expected recovery of US shale oil production and rising US oil inventories in January and February have led to an oil price correction over the past two weeks. We view this as a temporary and seasonal issue which will reverse over the coming weeks. The OPEC supply cuts that began in January will start to impact US inventories only now as transportation from the Persian Gulf to the US takes six to eight weeks. Furthermore, crude oil demand will grow in the coming weeks as refineries ramp up operations after the maintenance season.

US shale oil continues to dominate news headlines and investor interest, despite accounting for only 5% of global oil production. As a result, many developments in the remaining 95% of oil production remain hidden. Indeed, the decline of OECD oil inventories since the second quarter of 2016 has largely gone unnoticed. We were already in a tight oil market before OPEC started cutting supply.

Underinvestment risk

For the past six months, we have painted a scenario of tight oil markets for 2017 and beyond. This was reinforced last week when the International Energy Agency (IEA) highlighted that insufficient investment posed growing risks to the global oil supply.

Specifically, the IEA warned that global investments in oil and gas exploration need to grow from USD 450 billion to USD 700 billion for supply to be able to meet demand in the coming years. However, outside of North America, producers do not have much appetite for higher spending. The major oil companies are still focused on cost-cutting, funding their dividends and debt repayment. Global oil and gas spending is therefore likely to remain broadly flat in 2017, further impairing the global oil supply capacity. Even in the unrealistic scenario that global investment rises to the required USD 700 billion in 2017, it would take three to five years before this would translate to increased production.

US oil industry reflation in full swing

More US shale oil production is needed to fill this growing supply gap. This will only happen if oil prices rise from current levels, particularly as US shale oil costs are now trending upwards. Shale oil producers are now guiding for a 10-15% increase in service costs for 2017 whilst service companies suggest even higher numbers.

Some services and products like frac sand, pressure pumping and completion services are already approaching tight capacity utilisation and price increases between 20% and 40% are expected for 2017. We are well positioned for this recovery, with oil and gas technology currently representing the largest weight in our portfolio.

The underappreciated strong recovery momentum in North American oil and gas service activity and pricing led us to increase our exposure in the space at the expense of oil and gas producers, which will increasingly have to face service cost inflation.