The oil market has a problem and its not a global glut. Rather, its that supply wont meet rising demand in the long run, unless crude prices jump back to $100 a barrel.
Thats the message from one of the worlds best-known oil traders, Pierre Andurand, who in September 2015, forecast crude would slump to between $25 and $30 five months before prices dipped to around $26. But now the trader, who runs a big hedge fund specializing in the black gold, called Andurand Capital, is striking a remarkably upbeat tone on the commodity.
Demand growth has rarely been this strong, global oil reserves peaked 30 years ago, new oil discoveries are at all-time lows, and we think non-OPEC, ex-U.S., production is doomed at current prices, he said at the Sohn Conference in London last week.
So [production] is pretty much in terminal decline, and the question that everyone really wants to get an answer to is: Can U.S. shale really fill the gap? Another question is: Are current geopolitical risks priced in? he said.
The answer to both questions is no, according to Andurand.
U.S. shale to disappoint
As for U.S. shale, the hedge fund manager isnt convinced the rapid ramp-up in output will carry on. The Energy Information Administration currently forecasts that total U.S. crude production including non-shale output will average 9.9 million barrels a day in 2018, which would mark an all-time high. Production for 2017 is expected to average 9.2 million barrels a day.
However, Andurand points out that U.S. production has largely been flat over the past five months and says the EIA uses outdated assumptions to forecast future output. His argument? Shale companies will struggle to keep growth rates up as they deplete the most profitable wells and have to move to higher-cost locations.
[Shale producers] are starting to face pressure from investors to stop growing at all costs, but to look at growing within their cash flows. So we think U.S. production might fall half a million barrels a day relative to expectations, Andurand said.
Then theres the geopolitical overhang that could cap output in coming years. The oil trader pointed to current risks such as infighting in the royal family in Saudi Arabia; tensions between the Saudis and Iran; the prospect of declining production in Libya, Nigeria and Venezuela; and the U.S. potentially imposing more sanctions on Iran.
So you have a lot of potential downsides to supply, he said.
Reserves to decline 30% in 10 years
Oversupply and not undersupply in the global oil market has been a major concern in recent years, and the culprit behind the oil-price slide that hit in mid-2014.
Prices bottomed in February 2016 and have generally risen after the Organization of the Petroleum Exporting Countries and a group of non-cartel countries led by Russia agreed to slash production. The two groups decided last week to extend the deal to the end of 2018, saying they want to bring the market back into balance.
West Texas Intermediate crude
are now both trading close to two-year highs, around $57 a barrel and $62, respectively.
But oil prices should rise significantly higher than that, says Andurand. Heres how he lays it out: Demand for oil is rising. Reserves are getting depleted. That means new discoveries of supplies need to be made. And that exploration wont happen until prices are at a level that makes it worthwhile.
If oil prices stay at their current levels, then supply will peak before demand does, he said. Thats even as the car industry transitions to electric vehicles, shifting away from fossil fuels. In his view, oil demand will peak sometime between 2027 and 2035 further out than most analysts expect.
Today we have 100 billion barrels less in reserves than 10 years ago, he said. If we dont discover new oil, every year [reserves] will decline 3% a year, which means over 10 years you lose 30% of your reserves.
We think we need $100 oil to mitigate declines through 2030, he added, without giving a specific year when crude might regain the $100 level.
In the shorter term, Andurand predicts a price rally, too. For 2018, he said oil could go to $80 without the OPEC deal that was agreed last week, but much higher with the output accord in place.
Commodity analysts at Goldman Sachs this week also struck a relatively upbeat tone on oil for next year, although they werent as optimistic as bear-turned-bull Andurand. The Wall Street bank forecast 9% total returns on oil over the next 12 months, as OPEC and Russia continue their efforts to tackle the global supply glut.