There won’t be blood

DOUG By Guest Blogger Doug Rowat

Decades ago, when I had a few less grey hairs and counted as a good day any day that I didn’t get yelled at by an institutional trader or have to pick up his or her dry cleaning, I did some research work with my old firm’s oil & gas analysts. I remember being amazed at the time that the world actually consumed 75 million barrels of oil per day.

Today that figure seems small as global demand now flirts with the 100-million-barrel-a-day level and has continued to rise virtually uninterrupted over the past 20 years. Long-term global oil demand-growth is, of course, not spectacular averaging only about 1.5% per year, but the growth rate has been incredibly consistent regardless of the time period (1.3% and 1.7% annually over the past 10 years and five years, respectively, for example).

While the corresponding WTI oil price has been wildly volatile over the past 20 years, suggesting the need for active management in the energy space, the good years for oil can be extraordinarily profitable and the price has still averaged a reasonable 5% annual growth rate over the past two decades. Therefore it makes sense to build a long-term portfolio with at least some oil & gas exposure and we should, from an investment perspective, rid ourselves of the notion that renewable energy and electric cars will somehow loosen our grip on fossil fuel consumption any time soon.

Global Oil Consumption: An Uninterrupted Rise

Source: International Energy Agency; Bloomberg. 20-year quarterly chart

Shorter term, there are a number of positives for the oil & gas sector: a generally strong global economy, declining US inventory levels (down 14% since March), global supply and demand finally being in balance and a significant technical breakout for the WTI oil price (see chart below).

After Consolidating for 18 months, WTI Oil has made a Major Technical Breakout above Resistance


OPEC Secretary-General Mohammad Barkindo also recently stated that production cuts were the “only viable option” to restore stability to the oil market—another positive development. It’s hackneyed oil-industry wisdom, but the only cure for low oil prices is, of course, low oil prices. Typically, when oil prices are subdued there are three outcomes: 1) a reduction in spending on new projects, 2) an outright postponement of new projects or 3) production cuts—all of which lead to lower supply growth. New extraction techniques developed in the past decade, such as fracking, which led to the explosive growth in US production, signaled a major change for the oil industry and speculation became rampant that the oversupply would never work its way out of the market.

But it did (see chart below). The oil market has historically been pragmatic—albeit not always immediately so—and supply-demand has once again moved into balance. In fact, the correlation between global supply and global demand has been 97% over the past 10 years. That’s an efficient market.

Global Oil Supply & Demand: Once Again in Balance

Source: Bloomberg. While line = supply, orange line = demand. Shaded green = oversupply.

So the shorter-term fundamentals for oil remain, in our view, positive, which is one reason why we increased our clients’ exposure to Canadian equities earlier this year. But regardless of how near-term fundamentals develop, the longer-term pattern is clear: global oil consumption will rise and, despite its shorter-term inefficiencies, the oil industry eventually finds a way to create balance between supply and demand. And while it’s an industry that’s no friend to the environment, your portfolio should have oil & gas exposure. My car? Still takes gas. My house? No solar panels yet. My possessions? All made directly or indirectly with fossil fuels.

Invest in oil & gas. And if you feel guilty, buy a Prius plug-in.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.