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Could Cheap Oil Be Here To Stay?

A lot of us are expecting (and hoping) that the oil price will start to creep upwards before too long — especially those of us with investments in oil companies. And the conventional wisdom is that, as the current slump is caused by an excess of supply over demand that is actually not that great — demand for oil is extremely inelastic — only a relatively small reversal would be needed to turn that small excess into a small shortage, and bring about a significant rise in oil prices.

But are we being too optimistic to assume that? We might be.

The thing is, according to BP, worldwide reserves of commercially accessible oil and gas could easily double by 2050, partly due to improvements in technology enabling previously less accessible reserves (like shale) to be exploited profitably. In fact, BP’s head of technology David Eyton said that “Energy resources are plentiful. Concerns over running out of oil and gas have disappeared“.

Renewable revolution?

Coupled with the advances in renewable energy sources that should hopefully be coming our way in the next couple of decades, he could be right — although we need to bear in mind that renewable sources offer far lower energy density than oil or gas, and currently only contribute a relatively tiny amount to the world’s consumption.

So does that mean the oil business is dead and we should sell all our shares? I don’t think so.

For one thing, the medium-term supply of energy — and by that I mean the next 10 to 20 years — will still be heavily dependent on oil and gas. And though there might be a potentially booming supply of it, a lot of the world’s current reserves are actually not viable at today’s levels of barely more than $40 a barrel.

Estimates from different sources vary, but the consensus seems to be that much of Russia’s oil production is loss-making at current prices, along with around half the world’s deepwater oil and a lot of the world’s shale oil, oilsands and Arctic oil.

And smaller producers like Venezuela, Nigeria, Iran and even some Gulf states are suffering from break-even prices that are quite a bit higher than the current open market will fetch. That doesn’t necessarily mean they will cease production, because even at a loss level it can still be economically sensible to keep pumping the stuff if an economy has no more efficient industries to rely on.

Not sustainable

But, despite the massive uncertainty, I really can’t see prices being sustainable at sub-$50 levels for very long — although it could still take another year or two for the price to turn significantly.

And even at today’s prices, our top oil companies are still nicely profitable and are paying handsome dividends — although, admittedly, some of those dividends would not be sustainable for long without an upturn. BP’s mooted 7% dividend yields, for example, would not be covered by forecast earnings this year or next.

And the same is pretty much true of Royal Dutch Shell‘s high yields — although 2016’s expected payout might just be covered even without a price rise.

In the end, my thought is that we do need an oil price recovery over the next two or three years to maintain our big oil companies as attractive investments — but we won’t need as big a rise as many fear.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.