Real Asset Strategy

Timely discussion of the recent commodity, REIT, and real asset markets and what it may mean for investors.

June 15, 2017

John LaForge, Head of Real Asset Strategy

Oil’s Sad Reality

  • $100 per barrel oil remains a pipe dream. The world continues to overproduce oil.

What it may mean for investors

  • We recommend that investors remain on the sidelines until oil prices find a level in the high $30s to low $40s. At that point, we may become short-term bullish.

“I never know whether to pity or congratulate a man on coming to his senses.”
—William Makepeace Thackeray

Today’s oil bulls are frustrated—we get it. They continue to pine for the “good ol’ days” (2007-2014) when oil prices regularly traded north of $80 per barrel. During the last seven years of oil’s bull super-cycle (September 2007 through October 2014), oil traded above $80 per barrel 75 percent of the time. Since November 2014, oil prices have closed at $80 per barrel or higher exactly zero days.

Question: When oil prices have bounced in recent years, why can’t they seem to jump higher than $55-$60 per barrel? Answer: The main reason, which we shared in a CNBC interview earlier this week, is massive overproduction. While global oil producers may talk a good game that production should crater with prices around $40-$50 per barrel, they are having a hard time restraining themselves from producing. This is especially true with the largest petroleum producer in the world: the U.S. Here is the shocking, and frankly underappreciated, fact that we shared with CNBC: The U.S. is producing more petroleum today, with oil prices at $45, than it was producing in July 2014, the last time we saw $100 per barrel oil! This can be seen in Chart 1. The top panel shows the price of WTI (West Texas Intermediate) crude oil, while the bottom panel represents U.S. petroleum production. The shaded areas represent the days that WTI prices closed at $80 per barrel or higher.

Chart 1. Oil Price versus ProductionChart 1. Oil Price versus ProductionSources: Bloomberg, Energy Information Administration, Wells Fargo Investment Institute. Top panel, daily data: 1/31/1995 – 5/31/2017. Bottom panel, monthly data: 1/31/1995 – 5/31/2017. “Mmbd” is a unit of measure which stands for “million barrels per day.” Dates are selected to show the recent increase in production.

Oil bulls need to wake up. $100 per barrel oil will remain a pipe dream, and likely even $80 per barrel, until the world’s oil producers stop overproducing. We continue to hear that big cutbacks are on the cusp of happening. The evidence, however, implies otherwise. And the longer oil prices remain low and range-bound, the harder it will be for prices to bounce above $60—as production costs have dropped significantly, since 2014, which keeps more producers in the game. Also, the temptation to overproduce each time oil bounces toward $60 may be overwhelming for those countries that rely heavily on oil revenues to sustain their economies and social programs.

We are not expecting the price of WTI crude oil to climb anywhere near $100 per barrel over the next few years. Instead, we expect it to remain low and range-bound, bouncing between $30 and $60 per barrel. We are looking for the WTI crude-oil price level to end 2017 somewhere between $40 and $50 per barrel. On a short-term tactical note, there is the possibility that the WTI crude-oil price finds its way into the high $30s to low $40s. If this happens, we could become bullish in the short term.

Risk Factors

There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained.

Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.

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