Get Ready To Pay More For Oil, Says CLSA’s Chris Wood

Crude oil prices may increase further in the current cycle despite a recent correction.

That’s according to Chris Wood, chief equity strategist at CLSA. “While a further spike in oil prices to the $120-150 level would ultimately contain the seeds of its own destruction by destroying demand, it would do a lot of damage in the short to medium-term,” he said in his weekly investor note ‘Greed & Fear’.

Wood in the note highlighted key reasons that may lead to higher crude prices.

U.S. Shale Production

Average oil production per rig from seven major U.S. shale regions peaked at 16,703 barrels a day in May 2016 and has since declined to 7,614 barrels a day in June 2018, according to data provided by the U.S. Energy Information Administration.

This 55 percent drop in over two years means shale production is not increasing as much as expected, the note said.

Less Investment In New Supply

Wood said there has been a chronic underinvestment in new supply while energy demand continues to remain strong. This is because of a deceleration in the oil industry’s reserves and the reserve replacement ratio.

The reserve replacement ratio, measured as total oil and gas discoveries relative to production, declined to 11 percent in 2017 from over 50 percent in 2012, according to energy research firm Rystad Energy.

The US Energy Information Administration, too, said the total world upstream oil capital investments fell 45 percent from $578 billion in 2014 to $316 billion in 2016.

Iran Oil Supply

The U.S. said the world should stop importing oil from Iran by early November. Instead, American President Donald Trump has been pressing Saudi Arabia to increase production.

Iran, which accounts for about 5 percent of global oil supply, increased exports to 2.7 million barrels a day to generate as much revenue as possible before the sanctions hit.

“It is far from clear that this supply can be easily replaced,” CLSA’s note said.

Saudi Arabia increased its production to 10.5 million barrels a day, close to its highest annual average production clocked in 2016, and maintains a spare capacity of 2 million barrel a day.

“The risk is that if Saudi increases production more, it will further reduce spare capacity, creating the potential for an even bigger oil price spike should there be other supply disruptions because the industry would be running out of spare capacity,” Wood said.

The chief equity strategist, however, said the good news for investors in emerging markets is that a much higher oil price is unlikely to co-exist with a much stronger U.S. dollar.