Crude oil: Light at end of tunnel

Crude oil prices crashed during 2015 and made lows of $26 a barrel for the WTI crude and $29 a barrel for Brent crude, mainly due to the glut in supply. The Organization of the Petroleum Exporting Countries (Opec) meeting changed the oil markets, both dramatically and structurally. It began with Saudi Arabia relinquishing its supply management role and leaving the market to rebalance itself through prices. I have always believed the main reason for the sharp fall in prices was because it hovered between $90 and $110 for too long during 2012-2014, even as US crude oil production was moving up sharply.

Oil prices should have gradually declined during 2012-2014 but did not. So, during 2015, the fall was exceptional. During 2015, the global oil market was in surplus, which was as high as 1.8 million barrels per day (mbpd), though during 2013 this surplus was 0.52 mbpd. This surplus resulted in capitulation in crude oil prices at the end of 2015.

US crude oil production, which peaked in 2015, fell from 9.8 mbpd to 8.6 mbpd in 2016, the lowest output since May 2014 and likely to fall further. Investment in the energy sector was high during 2010-2014. It has, however, declined heavily in recent years with the sharp fall in prices.

The amount invested in global upstream oil capacity expansion during 2009 was around $300 billion. In 2014, it had reached $500 billion. The Opec earned $404 billion in net oil export revenue in 2015, which is a 46 per cent decline from the $753 billion it earned in 2014. Due to falling revenues, countries are not willing to increase investments in this sector. After the sharp fall in oil prices during 2015-2016, we have witnessed a sharp cut in investments, which will eventually balance the oil market as supply growth will remain muted. This is one of the most important reasons for us to remain bullish on crude oil. Billions of dollars have flown away from the oil market. On an average, oil markets have witnessed demand growth of one mbpd every year for the past five years and the gap between supply and demand is likely to decline from 1.85 mbpd in 2015 to one mbpd in 2016; during 2017, we expect it to drop further to below 0.75 mbpd.

After the sanctions over Iran's nuclear programme were lifted, there was fear that the oil market would be flooded with Iranian oil, which might cause the glut to deepen. But, Iran's production has moved up from three mbpd to only 3.85 mbpd. It is not able to ramp up production rapidly due to lack of foreign investment and its own unwillingness to undercut rivals on pricing.

Meanwhile, they have lost their share in oil exports. So, even if Iran's production moves up another 0.2-0.3 mbpd, it won't affect prices.

Going forward, we'll have a balanced oil market and any decline in oil prices should be used as good buying opportunity. The outlook on crude oil is bullish from the longer term perspective. We expect crude oil to test $60 a barrel by the end of 2017. On the Multi Commodity Exchange, we may could it testing levels of Rs 3,800-3,900 a barrel by the end of next year.

The author is head of research, Nirmal Bang Commodities