This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Ed Cowart, a manager of the Nordea 1 - North American All Cap Fund discusses some of the drivers of the oil market and explains why the current price for brent is optimal for both explorers and the general public.
Despite many important macroeconomic and geopolitical events, the past two years have seen oil prices remarkably stable at a fairly high level. With respect to Brent crude, now considered the industry’s global benchmark, prices have held between $100 and $115 per barrel over the past 24 months. Today’s price of $103 is not too far away from the price two years ago.
The US domestic benchmark, West Texas Intermediate (WTI), has been slightly more volatile – as the discount to Brent has expanded and contracted, based mainly on domestic infrastructure constraints. Despite this, the price of WTI also has been quite stable compared to the previous couple of years.
Absent geopolitical events disrupting supply on anything more than a temporary basis – we expect this high-price, low-volatility environment to continue. The main ‘big picture’ factors are these:
Despite warring factions and instability in the Middle East, whoever controls the oil ultimately will put it on the market. Barring some kind of widespread conflagration, no long-term disruption of oil supply is likely.
The ability of the industry to produce oil from existing reservoirs is inexorably declining at a rate of 8 % to 12% annually. On January 1 of every year, the major international oil companies must boost current reserves by these levels just to stay even. In effect, the industry is continuously ‘running up the down escalator’.
Energy demand and the intensity of energy use in developing markets is rising every year. While demand growth in developed markets is roughly flat due to conservation and more energy-efficiency use, demand from developing markets continues to grow. Transportation is a good example, with citizens moving from bicycles to motor bikes to automobiles. Oil usage per capita in China and India is currently less than a tenth of developed markets, but this gap will narrow over time.
In our view, oil prices around current levels represent a ‘sweet spot’ for both producers and consumers. Prices are high enough to incentivise exploration and production from the higher-cost sources that represent the only significantly opportunities to add to supply – such as oil shale, Canadian oil sands and offshore deep water. However, at the same time, prices are not high enough to destroy demand – for example, forcing motorists to adopt public transportation.
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