Cheap oil vs. cheaper renewables: what matters more?
Thiemo Lang, senior portfolio manager for the RobecoSAM smart energy strategy, and client portfolio manager Dominik Scheck examine the implications of low oil prices on energy efficient solutions and the renewable energy sector.
Commodity price volatility
Driven by new production techniques such as horizontal drilling – or fracking – US domestic oil production reached an average of 9.2 million barrels of crude per day in January 2015, the most since 1983, representing an expansion of over 3 million barrels per day within the last 3 years.
As a result, US crude oil inventories have risen sharply, reaching all-time-highs. OPEC’s unwillingness to introduce any production cuts has resulted in a global oil glut.
And following the recent agreement on Iran’s nuclear program, even more oil is expected to hit the market as Iran may soon be able to resume oil exports.
This could lead to an additional production increase of up to 1 million barrels per day within the next few months. On the demand side, the outlook remains consistent with the pattern established in recent years.
As a result, global demand is likely to rise by another 1 million barrels per day, mostly driven by emerging markets. As the current oversupply has yet to work its way through the market, oil prices will likely remain within the USD 50-60 range before potentially trending higher again.
In any case, as long as OPEC refuses to return to its former role as a ‘price maker,’ the oil price is expected to settle at a level equivalent to the production costs of the of the marginal producer, preventing the oil price from returning to triple digit levels for the foreseeable future.
Given the acute decline in oil prices over the past 9 months, a strong rebound may seem inconceivable to investors at the moment.
Looking back through history, however, one can identify two comparable occasions in which oil prices rose substantially following a sharp drop. During 1985–1987 and 1997–1999, OPEC’s reluctance to adjust supply at a time when international demand was slackening triggered falling oil prices.
At the time, the economic scenario in the US was similar to today’s environment, with healthy GDP growth rates and rising stock prices.
Oil prices dropped by more than 50% in both time periods, and even though OPEC did not adjust its supply, prices rebounded by 70% and 110% respectively.
Given these historical parallels, we have identified three factors that may lead to a similar outcome in the near future. First, with current oil prices at multi-year lows, stronger than expected consumer demand may move prices in the opposite direction.
As the European recovery strengthens and personal consumption in the US increases, demand for oil is expected to rise.
In addition, given its growth outlook, China may seek to boost domestic demand by further investing in infrastructure projects, which in turn would drive economic growth and demand for oil upwards.
Second, one should not ignore geopolitical risks. Venezuela, which has the world’s second largest proven oil reserves, is sitting on a domestic powder keg with soaring inflation rates and growing political unrest.