The oil price rose by almost 50% in 2016, making it one of the best years for the commodity in recent times. Of course, there was a significant amount of volatility throughout much of the year, and a near-50% gain didn’t always seem likely. However, the key factors that caused an increase in the price of black gold look set to continue into 2017. As such, this year could prove to be another successful one for investors in oil companies and in the commodity itself.
Production cut
Perhaps the most important reason why oil rose in 2016 was the OPEC deal to cut production. Although there was considerable uncertainty as to whether an agreement would be finalised, OPEC will reduce production by around 1.8m barrels per day. This commenced at the start of 2017 and could help to gradually bring supply and demand into equilibrium.
Clearly, it will take time for the imbalance between demand and supply to narrow. After all, there has been a glut of supply in recent years, which has worsened thanks to continued rising production that saw OPEC’s production levels reach an all-time high in 2016. But with non-OPEC countries also agreeing to a reduction in supply, the oil price should benefit from a falling surplus throughout the course of the year.
Rising demand
While demand for cleaner energy has risen in recent years and is forecast to continue to do so in future, demand for oil is likely to remain high. That’s especially the case when it trades at less than $60 per barrel. The incentive for developed and developing nations to transition towards cleaner fuels is smaller than it was when the oil price was higher. Therefore, it’s likely that demand for oil will remain robust.
Looking ahead, the developing world is likely to require higher amounts of oil in future years. For example, car ownership is forecast to rise rapidly in countries such as China and India as wages increase. Therefore, the idea that clean energy will quickly replace fossil fuels such as oil may prove to be inaccurate over even a relatively long timeframe.
Exploration cutbacks
A common response by oil companies to the lower oil price has been to reduce exploration and investment spend. This is logical, since it has helped to preserve cash and retain dividends at relatively generous levels. However, it also means that the amount of oil production set to come on-stream over the medium term may prove to be insufficient to meet growth in demand. As a result, the current oil surplus could quickly turn into a deficit.
While the effects of reduced exploration spend may not be felt in 2017, investors could begin to price them in as the year progresses. This could mean that investor demand for oil and oil-related stocks rises and pushes prices higher at a rapid rate.
