By: Jeff Pollock
November 6, 2017
The past couple of years have been a tough market for the oil bulls. Following the financial crisis, oil spent the next few years slowly climbing back up to the psychological $100 per barrel level. In 2011, it finally traded in the triple digit range and managed to stay (for the most part) above $100 until 2014 when everything came crashing down.
Recently, pricing has improved. In fact, oil now trades in a bull market after appreciating close to 35% since June. Today, fresh off the heels of Saudi Arabia’s tumultuous weekend, the price of West Texas Intermediate (WTI) jumped $1.71 a barrel to $57.35, its highest level since July 2015.
The question going forward is where oil prices head next. Canadian investors have little choice but to form an opinion. After all, 20% of the TSX’s value is derived by energy companies.
Contrary to popular belief, there’s no lack of demand for oil consumption. Between 2011 and 2016, global demand grew by a total 7.6%. Most of this growth (69% of it) emerged from the Asia Pacific region where demand jumped by 16.1%. Only in the European Union was there a decline (-4.1%). Next year, the IEA forecasts global demand to rise 1.4%. While many believe electric vehicles will render the commodity obsolete, growth from 1.2 million electric vehicles today to 100 million in 2035 will only take 1.2 million barrels of oil per day out of the system. To give that some context, 96.6 million barrels were consumed each day in 2016.
However, despite a positive backdrop for demand, the proliferation in supply, most notably south of the border, will likely continue to weigh on its price.
Although no longer the force it once was, OPEC (which controls 40% of the supply) agreed to curtail production by 1.8 million barrels per day until March 2018. It now appears committed to extend that same cut until the end of 2018. While less production is surely bullish for its price, the US and Canada are collectively expected to add 2.1 million barrels of oil per day in 2018, entirely offsetting the production cut.
Beyond the expectation for more supply, higher prices incentivize companies to increase production. North of $50, US shale producers are cash flow positive. Consequently, it’s difficult to foresee an environment where oil can top $60 for a sustainable period.
Given these facts, our Investment Committee has been cautious to invest client capital in the sector. We’ve stuck to companies with positive free cash flow, the ability to pay (and increase) regular dividends, and accompany Balance Sheets that enable the business to make lucrative and accretive acquisitions of troubled competitors in this depressed environment.
This Blog is made available for general information purposes only. The information provided is believed to be reliable and accurate at the time it is posted. However, Vestcap Investment Management Inc. does not guarantee that the information is accurate, complete, or current at all times. The information is not intended to constitute financial, accounting, legal, insurance or tax advice and, should not be relied upon in that regard. You should consult with a professional prior to acting on any information.