The price of oil faces an uphill battle

The price of oil has recovered somewhat, partly due to more demand. This has raised the prices of producers. But higher oil prices lead to more production causing oil prices to face a continuing uphill battle. The Investment Reporter recently analyzed 24 oil and gas stocks, rated only 10 as buys and names the four ‘best buys’ from among the ten.

The price of West Texas Intermediate—North America’s oil benchmark—is up sharply from its recent low of a little under US$26 a barrel. Even so, the price of oil faces an uphill battle. Higher prices will lead to renewed production.

In the past, OPEC (the Organization of Petroleum Exporting Countries) often reduced supply to support the price of oil. This raised oil production in higher-cost countries. As a result, in November 2014, OPEC leader Saudi Arabia decided to flood the market. The idea was to reduce the price of oil and drive out high-cost producers. It has largely worked.

Worldwide investment in oilfields is expected to plunge by 25 to 30 per cent in 2016. This is on top of a similar drop last year. That’s likely why the price of oil has partly recovered. But prices that are even higher would bring back higher-cost producers.

Higher oil prices will create more production

Many U.S. producers use shale drilling to tap previously unavailable energy. It also renews old plays. Shale production fell along with energy prices. But it could come back as prices rise. This would reduce U.S. oil imports. What more, the technology continues to improve and to cut the cost of shale drilling.

Other high-cost production will continue. Consider the Alberta oil sands. True, lower prices means shelving new oil sands projects. But as long as prices cover the cost of producing more barrels, existing plants will still operate. Similarly, with little else to sell to raise cash, Russia will keep exporting energy.

Iran wants to rebuild its production to the level it was at before it faced economic sanctions. Likewise, Iraq wants to rebuild its production to where it was at before the American invasion. This should overcome lower production in Nigeria and Venezuela.

Then again, the world’s demand for oil is expected to grow by 1.6 per cent this year. Both the U.S. and Britain are now expected to grow by a respectable 1.8 per cent in 2016—the fastest in the G7 (Group of Seven industrial countries). Then again, the U.S. uses oil less than in the past and Britain’s vote to leave the European Union may mean its economy will now suffer.

The euro area’s economy is now expected to grow by 1.5 per cent in 2016. China, the world’s second-largest economy, is growing by 6.6 per cent. Japan, the world’s third-largest economy, by only 0.6 per cent. All three are major oil importers. Europe would likely embrace imports of liquefied natural gas from North America. This would cut their dependence upon supplies from Russia—supplies which are prone to interruption.

In the short- to medium-terms, some fuel consumers will switch to cheaper natural gas if they can. In the long run, the construction of plants that produce liquefied natural gas for export will eventually alleviate or eliminate the glut of this commodity.

Environmental concern is leading to the development of alternate energy that could compete with oil and gas. Hybrid cars, for instance, use less energy. More important, electric vehicles will require no oil.

Revealed: The four best oil and gas stocks to buy now

Our oil and gas stocks survey offers advice on 24 producers. We identity four ‘best buys’. We believe that it pays to stick to the strongest producers. They can survive industry downturns and thrive when the industry recovers.

The full survey appeared in our June 24, 2016, issue. And the four best buys?

They are Canadian integrated oil and gas producer Suncor Energy (TSX─SU), senior producer Enerplus Corp. (TSX─ERF), junior producer NuVista (TSX─NVA) and, from among U.S. and international integrated oil and gas producers, French multinational Total S.A. (NYSE─TOT).


The Investment Reporter, MPL Communications Inc.
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