Oil supply shock set to boost beleaguered energy markets

1 April 2015

Mark Lacey

Mark Lacey

Portfolio Manager, Global Energy & Precious Metals

John Coyle

John Coyle

Fund Manager and Global Sector Specialist

The energy market is setting up for an enormous supply shock through the latter half of 2015 and into 2016, driven by strong demand and shrinking supply.

That means at some point in the not too distant future, equity market players should move from their current extreme bearishness to something less manically depressed.

Oil suppliers responding quicker than expected

The general consensus is that markets are grossly oversupplied, and will remain oversupplied until substantial amounts of current production are forced offline, a process that could take more than 12 months.

We think, however, physical crude markets will be on the turn by mid-2015. This is likely to occur as demand strength comes through in response to lower prices.

We believe we will have irrefutable evidence of a substantial supply response in both the North American shale plays and the North Sea conventional volumes by mid-year.

As these two forces combine the net balance between supply and demand could begin to look very different.

Outlook risks

There are risks to adding exposure to the energy sector:

  • Oil demand may come up short of expectations if we have an emerging market crisis.
  • The Saudis genuinely want a price war and decide to increase production, as opposed to the current strategy of simply talking markets down.
  • US volumes prove more resilient than we expect despite savage cuts to capital expenditure, which would point to prolonged weakness in oil prices.

Time running out to reposition

Weakness in physical crude markets is likely to peak around May/June as inventory piles up in the US and in floating storage facilities.

But we believe the window for closing underweight positions is short and crude prices will be substantially higher than they are today come the end of 2015.

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