This topic was covered in the latest edition of Prospects, where Tim Guinness, manager of the Guinness Energy Fund and a leading commentator on energy price, suggested that oil had stabilised, a call I now agree with. My rationale is broadly:
- The rig count in the US seems to indicate a further removal of capacity. I think that some of this is temporary.
- Russia is making noises that it would like to s ee a higher oil price negotiated with OPEC. I would note that the extended Russian involvement in Syria places further budgetary constraints on them domestically, on top of Western sanctions over the Ukraine.
- Saudi Arabia and the Gulf States are suffering from economic pressure as a result of lowered oil prices. The Saudi budget deficit has ballooned considerably as social costs and domestic subsidies have grown, keeping the population happy. In addition, the incursion into conflict in Yemen is running up considerable ongoing costs and is not helping the popularity of the ruling family. It is notable that the Saudis have had to tap international bond financing.
- We see continuing attrition within OPEC and steady, if unspectacular, demand supply growth. There is considerable improvement in the demand/supply balance, as highlighted to us by Tim Guinness and his team.
- Finally, we are seeing some merger and acquisition activity begin this week in the Canadian oil sands arena. The ongoing pressure for opportunistic bids highlights value in the sector and reassures me that we are pretty close to a trough in valuations.
I believe that the rally that we have seen over the last few days confirms this thesis. I am not a massive bull of oil as so much cost-effective capacity has now emerged within the North American shale industry; the OPEC action has forced a lot of cost efficiency into the US, as Goldman Sachs, for one, have been keen to highlight, and the sector has not been bankrupted wholly, as OPEC might have hoped. As such, I expect any concerted rally to see an uptick in the North American rig count.
Basically, coming out of this downturn there is now a structural impediment to pricing, in that shale has emerged as a lower cost swing producer that should re-emerge as pricing improves. As such, I expect oil to trade, given low international growth rates, within a US$50 to US$70 per barrel r ange for the medium term. Shale effectively caps any more pronounced rally in oil prices.