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Quarter-End Insights

Energy: All Roads Point to Oversupply in 2018

Nothing is certain in the world of oil, but a crude awakening for energy investors could be near.

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  • Crude fundamentals look healthier than they've been for years, largely due to voluntary curtailments from OPEC and its partners. By giving up 1.8 million barrels per day combined, this group has engineered a supply shortage to realign global inventories with the long-term average before the cuts expire in March 2018.
  • The cartel might pay a steep price for any near-term benefit, however. We believe it is underestimating the ability of shale producers in the U.S. to rapidly increase volumes in a $50-$55/barrel environment (West Texas Intermediate). After several upward revisions, the International Energy Agency currently expects U.S. crude production to end the year 0.8 mmb/d higher than year-end 2016, and that looks conservative, as we forecast 1 mmb/d. The rapid U.S. shale growth in the back half of the year will meaningfully increase U.S. oil supply.
  • Once the OPEC cuts are lifted, full OPEC production coupled with rapidly growing U.S. output is likely to outstrip near-term demand growth and could easily tip the industry back into oversupply in 2018. Our 2018 and midcycle forecasts for WTI are still $45/bbl and $55/bbl, respectively.
  • The energy sector looks fairly valued at current levels with an average price/fair value of 0.95. Still, on a relative basis, energy is one of the cheaper sectors, with several others trading at a price/fair value above 1.00.

Joe Gemino does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.