Oil - the long and short of it
OIL markets have struggled for direction since resurging from the lows plumbed in the first half of last year. OPEC is clearly trying to do its bit on the supply side, however, prices seemingly remain locked in range. So what gives?
We see oil prices drifting higher towards the end of the year as a better balance between demand and supply sees increasing draws on inventories. Improving global demand is part of that story, as is the extended OPEC supply agreement of last week.
However, absent a major supply shock, we are not expecting a return to $100 any time soon. The new reality in the oil industry seems to be one of dramatically reduced costs. This is allowing many more producers to make money at levels unthinkable just a few years ago, suggesting that the oil market will remain well supplied for the foreseeable future.
There are also some interesting long term challenges now gaining a bit more credibility. Whereas the industry chatter since the 1950s has centred on the concept of ‘peak oil' – the idea that finite resources will be exhausted before long – debate now seems to be turning towards ‘peak demand'.
As the IMF observed in a recent report, an abandonment of oil would not be unprecedented. The US energy and fuel mix went through two dramatic changes around 1850, as coal toppled wood and then oil and gas did for coal in reasonably rapid succession. Oils rise in the early 20th century came largely as a result of a transportation revolution as horses were swapped for cars. Many argue that it will again be a transportation revolution, ie- the move to electric cars, that will help speed an eventual transition away from oil.
If car displacement follows the same pattern as the drop in horse ownership, then 90 per cent of the US market could be electric vehicles (EV) in little over 20 years. This is obviously way in excess of current consensus expectations, which tend to be based on extrapolations of current trends in EV adoption and battery cost reduction.
Much of this scepticism of EV's potential is eerily reminiscent of the early days of the cell phone market. In the early 1980s, McKinsey produced a report for AT&T on the market's potential, which predicted a market of 900,000 cell phones by 2000. The actual number turned out to be 120 times larger at 109 million phones.
The McKinsey report serves to remind us of how limited the view of the road ahead has always been to even the most assiduous of forecasters. In a sense, this makes picking out the long term winners from the evolution and adoption of new technologies a very hazardous game.
More broadly though, the continuing prospects for such technological leaps are a large part of why we urge clients to always have some skin in this game. Certain geographies and sectors will inevitably and unfortunately endure disruption, but the world in aggregate tends to benefit, something that is eventually reflected in aggregate corporate earnings and therefore share prices.
In the short term, the sharp changes in the oil industry's cost curve and the dampening effect that has on our outlook for oil prices leads us to call time on our moderate overweight to the energy sector in the developed world. We use the proceeds to reduce our strong underweight in consumer staples across the developed world to a more modest negative position.
:: Jonathan Dobbin (firstname.lastname@example.org) is head of wealth and investment management NI at Barclays. He can be contacted on 028 9088 2925.