OPEC recently released its latest World Oil Outlook, and understandably, it's not too upbeat. With vast amounts of oversupply coming from both the U.S. and OPEC itself, the price of oil has slid over 60% since its highs roughly 18 months ago. Meanwhile, the stocks of major producers like Exxon Mobil (XOM) and Chevron (CVX) have tumbled by over a third. Still, there's reason for hope.
While OPEC does not see oil prices returning to triple-digit territory within the next 25 years, it does expect oil prices to rise by an average of about $5 per year, reaching $80 per barrel by 2020. From the latest closing price, that represents a gain of over 100% in just four years. Most of this has to do with a rationalization of oversupply. Based on recent reports, the probability of oil returning to $70+ in a few years is getting higher.
Budgetary pressures should end OPEC's policy of continued pumping
OPEC is comprised of 12 members: Algeria, Angola, Ecuador, the Islamic Republic of Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. While OPEC doesn't pump a majority of global oil production, it does control a big majority of world reserves. This gives it a huge ability to control oil prices from the supply side.
Lately, many OPEC members have refused to cut supply to a reasonable level, hoping instead to force out other producers and gain market share. This is becoming increasingly unfeasible. Based on the budgetary breakevens for nearly every OPEC country, most members are currently running massive deficits.
For example, last week, Saudi Arabia announced a sharp reduction in its 2016 budget to control a worsening deficit, which is steadily draining the kingdom's financial reserves. In all, over 80% of OPEC production is under increasing financial pressure to stabilize global supply.
Increased supply from non-OPEC countries simply isn't there
With crude prices at 11-year lows, the world's biggest oil and gas producers are facing their longest period of investment cuts in decades. OPEC believes $10 trillion will be necessary over the next 25 years to ensure adequate oil supplies. About $250 billion each year will have to come from non-OPEC countries.
Rystad Energy research shows that while the oil industry "needs to replace 34 billion barrels of crude every year - equal to current consumption, investment decisions for only 8 billion barrels were made in 2015." This amount is less than 25% of what the market requires long-term. E&P spending has been taken down by $250 billion in 2015 versus 2014, and Rystad Energy forecasts it to reduce further by $70 billion in 2016. Additional spending cuts in 2016 could occur with the current post-OPEC meeting oil price decline.
U.S. shale oil, the original cause of the over-supply in oil, is also seeing massive production cuts. Nearly every region has seen production declines in the past month, with year-over-year comparison set to look even more dire.
Demand growth is lower, but still there
While supply is being cut in some countries, and set for declines in major producers such as OPEC, the demand story remains solid. While growth is expected to be below historical rates, it should continue to climb at least over the next decade. These two market forces should balance the market sooner than later, possibly brining OPEC's $80 oil prediction by 2020 into fruition.
This article first appeared on
GuruFocus.