Morgan Stanley analyst Adam Longson believes the current glut in global oil supply is a self-inflicted problem that will correct itself in 18 months. Emerging markets demand for distillates like gasoline, combined with declining production in the United States, will create a stabilization in a global energy market that has, to date, failed to find a sustainable price range that reflects the global supply and demand outlook.
Mr. Longson is not as optimistic on the near term for the West Texas intermediate crude price; as he noted in a recent research report, "The addition of new supply from Iran in 2016 will likely keep the market oversupplied … [and] as a result, we see limited upside for WTI and Brent over the next 12 to 18 months."
The analyst blames OPEC for the ongoing oil glut, writing "if not for a large increase in OPEC supply, we could argue that there might be no oversupply in the market today."
The first chart, comparing OPEC and U.S. oil production growth, illustrates his case and makes clear that December, 2013, was an important inflection point for the Organization of Petroleum Exporting Countries. At that point, OPEC members – tired of losing global market share – began ramping up drilling operations despite the fact that U.S. production was increasing at a 20 per cent annual pace.
OPEC is now growing production at a 2.4 per cent annual pace while the Americans are sending 13.5 per cent more oil to market than a year ago. This is a game of "who'll-cut-production-first" chicken that has caused oversupply and sent crude prices lower.
Morgan Stanley's Mr. Longson believes a rising standard of living in the emerging markets, and a subsequent increase in gasoline consumption, will eventually create oil price stability.
"Transportation fuels – the real driver of oil demand – have seen strong growth since 2013, with demand accelerating as prices fell," Mr. Longson noted. "Gasoline demand is particularly robust, continuing to grow at a double-digit pace in many emerging market countries, including China, as consumer wealth and vehicle penetration increase."
Chinese government officials are attempting to wean the economy from its easy credit-driven infrastructure growth strategy and toward consumer spending. The second chart shows the effects – despite the overall slowdown in the Chinese economy, gasoline demand has continued to climb as aggregate consumer wealth and spending continue.
In India, the trend in gasoline demand is also positive. Year-over-year consumption growth has averaged 14 per cent so far in 2015. (Demand levels are calculated slightly differently for each country, but show a clear trend. China's data are calculated in terms of gasoline demand per person, while India's gasoline demand is calculated by actual volume of gasoline sold.)
Mr. Longson's well-argued forecast provides a light at the end of the tunnel for Canadian investors in the energy sector. An 18-month wait will likely seem interminable, but patient investors will once again see promising investments in the oil patch as long as Chinese consumption growth continues on the current path.
Follow Scott Barlow on Twitter @SBarlow_ROB.