At a time when oil prices have just hit a four-year low, it might seem odd to be planning for scarcity. But many investors are doing just that.
Tom Nelson, co-portfolio manager of Investec’s Global Energy fund, says Investec thinks oil supply will struggle to meet demand over the next five years. “There are considerable unknowns when it comes to oil and gas supplies in the medium to long term.”
Russ Koesterich, chief investment strategist at the asset manager BlackRock, says the world is not “running out of oil”, but adds: “There’s a good chance that oil supply may be tighter in future than expected.”
Threats to global oil supply security include production decline rates, lack of exploration success, geopolitical hazards and lower capital expenditure delaying big projects, Mr Nelson says.
Iraq and the US have been seen as key sources of oil production, but question marks hang over both, leading to expectations of a strong rebound in prices. In its medium-term oil market outlook, published in June, the International Energy Agency, the west’s energy watchdog, forecast a “robust” increase in global supply capacity of 9m barrels a day to 105m b/d by 2019.
But Iraq was expected to account for 60 per cent of production growth within Opec, the producers’ cartel, a figure that the country’s conflict calls into question, although it has so far left most production intact. “This expansion looks increasingly at risk,” the IEA added.
Mr Nelson believes the IEA’s estimate is overly optimistic, and points out that the IEA has consistently overestimated non-Opec production growth. He has increased holdings of US and Canadian exploration and production companies in his portfolio, in anticipation of tightening supply.
Other political risks in oil-producing countries include sanctions on Russia, elections in 2015 in Nigeria and simmering unrest in Venezuela.
Not all analysts in this sector share Mr Nelson’s expectation that supply will face strains within five years. Jon Clark, partner in oil and gas transaction advisory services at EY, says: “I’ve not seen analysis that suggests a medium-term shortfall in supply, absent a disruption event. There are also potential demand disruptions, largely related to economic outlook.”
The managers of the high performing Guinness Global Energy Fund believe the recent price lows have resulted from Saudi Arabia, Kuwait and the United Arab Emirates temporarily increasing production by 2.9m b/d. They think the Middle Eastern producers will cut back to ensure price stability.
There are also question marks over whether the US shale revolution, which has helped increase energy supplies and drive down prices, will prove a lasting transformation.
Will Riley, Guinness Global Energy co-manager, notes that current low prices are likely to have a rapid effect on capital expenditure in the shale oil sector, since companies tend to operate “hand to mouth”.
The Guinness managers see strong potential in the US’s existing oil sites, but adds “the US has struggled to find another large shale resource, despite three years of trying”.
The Guinness managers hold a full 38 per cent of their portfolio in exploration and production, with a strong focus on the US. They are also biased towards oil against other energy sources, as they expect prices will rise to between $130 and $150 in nominal terms by 2030.
A further concern for investors is a potential lack of investment in new sources, as oil majors cut back on capital expenditure. Mr Nelson believes there is already a problem of under-investment, citing a JPMorgan survey that predicts a fall in upstream spending in 2015 – only the second in a decade.
“We believe this under-investment will compound the structural problems already faced by the industry,” he adds.
Mr Riley said capital expenditure is being reduced sharply by a switch among “super major” energy producers to “value-over-volume” strategies, a trend led by Total of France.
“They are abandoning long-term production growth targets in favour of a refocus on return on investment for individual projects and overall return on capital,” says Mr Riley.
Ogan Kose, senior managing director at the management consultancy Accenture, says buyers of crude oil are meanwhile seeking to lock in the current low prices as much as possible through long-term contracts.
The managers of the Artemis Global Energy Fund predict “sustained oil shortages” as a result of the spending cuts and, like their rivals, have increased holdings in exploration and production stocks.
Mr Kose, who specialises in commodity trading and risk management, adds: “In the medium term there is enough crude, but at what price can you extract that crude? The majority is going to start coming from offshore platforms and other expensive locations. There will be enough crude, but not enough at cheap prices.”
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