Market outlook

Oil prices headed permanently higher

Arnaud du Plessis of CPR Asset Management reckons that oil prices will hold steady at or around today’s higher prices, despite eventual production cuts. Photo: CPR AM

Arnaud du Plessis of CPR Asset Management reckons that oil prices will hold steady at or around today’s higher prices, despite eventual production cuts. Photo: CPR AM

Despite being a cyclical sector, the oil price is not expected to fall at a time when analysts agree that the global economic cycle is slowing down, according to Arnaud du Plessis.

If the covid health crisis has strongly affected the energy and oil sector, "the market has since adjusted rather well", notes Arnaud du Plessis, thematic equity manager and natural resources specialist at CPR Asset Management.

"The oil sector has been quite shaken. In early 2020, the world gradually came to a virtual standstill because of the health crisis. Transport activity came to a halt, leading to a sharp drop in the consumption of oil products. At its lowest point, there was a drop in consumption of almost 25%.” And if consumption has since started to rise again, it is still below "normal" consumption, “by 10% to 15%", the analyst says.

Controlled supply

To prevent the market from becoming completely unbalanced, the producer countries within OPEC, and Saudi Arabia in particular, have reduced their production.

Now supply--which was also disrupted by the closure of many production sites following the lockdowns --is gradually recovering. "OPEC decided in July to start adjusting its production. Over the next 18 months, the decision was taken to gradually increase oil production by around 400,000 barrels/day month by month in order to catch up with the pre-crisis production level which was around 5.8 million barrels/day above current production,” states du Plessis.

"This is a very important event because the oil market is first and foremost a balance between supply and demand. If one shifts too much in relation to the other, it can generate very significant price movements up and down. OPEC has somehow become much more disciplined.”

This controlled balance has finally been well accepted by the market, as evidenced by the fact that prices are holding up well: "Brent futures are around $76. We are at high levels compared to what we saw during the health crisis. At the low point of 2020, prices were down to $35 compared to $60 at the end of 2019. Today, prices have exceeded pre-crisis levels. Prices are even at their highest since 2015. OPEC countries have managed the post-crisis period perfectly."

Structural decline in consumption

The fear is that with the rise in Saudi Arabia's production, the market could find itself in surplus, which would ultimately put prices at risk.

This is not the most likely scenario, barring a very cyclical shock.

"What we need to bear in mind, while production remains under control, is that oil consumption is approaching a peak," du Plessis points out.

"Why? Half of all oil is used for transport, planes, boats, roads, etc. And with the electrification of transport, and especially cars, which is going much faster than we could have imagined, at some point a whole segment of oil consumption will disappear. The market will have to balance itself against this. It's not necessarily a big deal because there will come a time when there will be much less oil than there is today."

Du Plessis expects the market to gradually adjust to this trend. This is what the oil companies have started to do, as they have very significantly reduced their oil investments. "Eventually, I think production is going to plateau and maybe even decline."

70 dollars is a break-even price that is quite decent for the whole chain
Arnaud du Plessis

Arnaud du Plessissenior portfolio managerCPR Asset Management

And he notes that in order to achieve the objectives of lowering CO2 generation, oil and gas production would have to fall by 35% compared to current levels.

"The major oil companies have understood this. Many of them are now planning to divest a number of assets in order to gradually adapt to this new environment and actively participate in the energy transition. Take the example of Total Energie, this major oil company is becoming a major player in renewable energies. And while renewables still represent only a small part of its business, this positions it as one of the most important players in the renewable sector in both wind and solar."

It is against this new backdrop that the adjustments will have to be made.

According to du Plessis, we are therefore heading towards a new, rather subtle balance where, on the one hand, consumption will fall while, on the other, the oil companies will sell their assets and stop investing in the sector. He also expects the market to remain balanced. "It is relatively likely that oil prices will remain close to today's levels. We think that the right level of equilibrium for oil prices is around $70. $70 is a break-even price that is pretty decent for the whole chain."

Originally published in French by Paperjam and translated for Delano.