Over the past sixteen years, oil and gas markets have witnessed a technological and supply driven drop in the oil price as a direct result of the shale revolution in the U.S. Shale provided a new source of oil to meet global demand growth. Lateral drilling led to significantly increased recovery rates. Numerous pipelines were built that allowed the companies to get oil out of the mid-continent and to the U.S. Gulf Coast. A shorter business cycle for shale projects encouraged a significant amount of capital to become available. The availability of capital and the increase in production along with the building of excessive storage capacity and tanker fleet expansion led to an increase in global oil inventory and subsequently a sharp drop in the oil price. All this was happening whilst the global demand growth slowed down, although did not contract.

The shale oil production in the US has created a completely new dynamic in the way the markets and the oil and gas industry balance supply and demand. On the supply side, OPEC is no longer the only swing producer. US producers have learned how to produce oil at low cost and they are now capable of fighting battles with OPEC for market share. The geopolitical situation in the OPEC countries seems so far to have had only limited impact on supply. For perhaps the first time in over a century high geopolitical risk is associated with low oil-at-risk. Production in Libya, Venezuela, and Nigeria continues despite ongoing in-country conflicts. Similarly, profound national political challenges has had no limited effect on oil production in Iraq, despite efforts by ISIS to seize several oil fields especially in the south. Operation of the oil fields mostly by joint ventures means that has been minimal disruption of oil supplies, as local partners have fought hard to safeguard operations and maintain production. Saudi Arabia has so far been the key state with sufficiently large spare capacity to influence decision making, but a return to the market of Iranian oil and gas may change the balance of power inside the cartel.

On the demand side, global growth is fuelled by OECD countries due to colder-than-normal winters in the north and higher demand from industrial fuel users, as well as China and India. Although demand growth in China started to slow in the five – year period to 2016 due to structural changes that have seen focus shifting from rapid industrialization and infrastructure spending to a more consumer-focused economy, China’s demand for oil will still help push the long-term oil prices up. In India the situation is different, as the need for transportation fuels will increase as economy grows, and despite a growth in electric vehicles use, which the Investment Manager believes will have only a limited impact for the next 10 or so years in global transport demand.

A growing global economy and record high crude stocks form the basis of a flat crude-oil price futures curve for the next four to five years. At such prices many projects will remain stranded especially in Canada, Australia, and Brazil. This scenario may create spare production capacity given that OPEC and non-OPEC crude and stock rises may not be sufficient to provide for the increase in demand leading to a rise in price expectations in the longer term – Augustus believes above US $60.