Is the oil price finding a bottom?

Is the oil price finding a bottom?

23-02-2016 | Insight

Oil prices are at record lows, having fallen to levels of before the Great Financial Crisis. Four major OPEC members recently announced a freeze in production. Will the oil price find a bottom this year?

  • Dirk  Hoozemans

Speed read

  • Saudi-Russia production freeze a welcome first step
  • US rig count falling fast as producer balance sheets are stretched
  • Inventories at record highs – demand to the rescue?
  • Oil market expected to rebalance in late 2016 or 2017

Oil prices have been plummeting since 2014. This is shown in Figure 1. The main driver of this fall is record high supply. OPEC production currently amounts to 28.7 million barrels of oil equivalent a day, while US unconventional oil production has shown record growth in recent years. 

Source: Bloomberg

In a move to address the growing oversupply of crude and help push up prices from their low levels, oil giants Russia and Saudi Arabia, Qatar and Venezuela agreed last February 16 to freeze output at January levels, provided other oil producers would join them. Iran, although welcoming the decision, said it would not join the freeze, still being in catch-up mode after the lifting of the sanctions. Although the decision is a freeze and not a cut, it is a first step. Oil markets reacted favorably to the news.

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates

Low oil prices will impact supply

As production levels of the major oil exporting countries will stay the same, the US will now become the swing producer. The US oil sector finds its balance sheets under great pressure and is cutting capital spending and operating costs dramatically in order to live within its means. Spending in North America was already down 35% in 2015, and is expected to fall by another 30% this year. This is illustrated in Figure 2, which shows a substantial decline in the number of rigs drilling for oil in the US. As a result, US onshore production, especially shale oil production, will go into decline this year. 

Source: Baker Hughes

Demand is also crucial

As inventories are also very high, demand will be a crucial factor. In western countries, where price elasticity of demand is high, low prices at the pump will help drive consumption. This way, the low oil price will be the cure for the low oil price. Global demand growth projections suggest a decent year in 2016, in line with mid-cycle averages (i.e. growth of some 1.3 million barrels a day).

‘The only cure for the low oil price is a low oil price’

The oil futures curve is still in contango, which means that futures prices are higher than spot prices. A higher futures price reflects expectations of a gradual rebalancing of the oil market later this year or next year. In recent weeks, the curve has shifted upward which points to tightening of the market as well. This may well be the start of a bottoming out process in the oil price. We expect Brent oil prices to move in a range between USD 35 and USD 65 per barrel this year. In the longer term, they are likely to creep up to justify investments in non-shale oil activity, such as deepwater developments.

No major effect from alternative energy (yet)

Alternative energy is not expected to be disruptive to oil markets for several years to come. Solar energy, for example, is mostly a threat to coal rather than oil as it displaces coal-fired power generation by a cleaner source of energy. And while the electric vehicle market is growing, it will take years for EVs to really make up a significant part of the global car fleet. Low oil prices have made the cost of ownership of traditional combustion engines more competitive again as well. Growing EV penetration will also require massive investments in infrastructure and big improvements in terms of battery technology. We believe that in the medium term, gasoline and diesel will still be the dominant fuels in transportation. 

Oil in the Robeco NV portfolio

The Robeco portfolio has a neutral weight in the energy sector. In general, we prefer companies with strong or improving cash flow generation, healthy balance sheets, dividend support, and management teams that are focused on cost & capital efficiency. 

Subjects related to this article are:

Important legal information

The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.

The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.

Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult for a list of FINMA registered funds.

Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.

This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.

I Disagree