Will Low Oil Prices Last Until 2020?

Don’t expect a rebound in oil any time soon. Energy investors should stick with integrated operators like Imperial Oil Limited (TSX:IMO)(NYSE:IMO) or Exxon Mobil Corporation (NYSE:XOM).

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Low oil prices could be our new reality, or at least that’s what the International Energy Agency believes.

This week, it released its highly anticipated World Energy Outlook for 2015. In its base scenario, it forecasts that oil prices won’t rebalance until 2020, reaching only $80 per barrel in 2020. Of more concern, it sees massive potential downside to its prediction. They believe we may see “prices in a $50-60 a barrel range that last well into the 2020s before edging higher to $85 a barrel in 2040.”

Low oil prices for a longer time frame would be devastating news for Canada’s energy industry, especially for high-cost oil sands producers like Canadian Natural Resources LimitedSuncor Energy Inc., and Canadian Oil Sands Ltd.

How likely is this scenario?

The oil market has changed forever

In past oil routs, prices were ultimately affected by supply changes. Either OPEC (namely Saudi Arabia) voluntarily rebalanced the market with supply cuts, or higher-cost output was rolled back. To restart production on most wells could take at least a year. This allowed investors to more accurately predict changes in supply, which is a more volatile price influencer than demand.

Today, supply changes have been revolutionized. Now, U.S. oil shale producers control marginal production. This means that they are largely in charge of price changes. Unlike the slow production cycles in the past, shale plays can respond quickly to price changes, varying investments in rapid fashion. At the first signs of higher prices, shale producers can increase production within months. This puts an effective cap on oil prices, for as prices rise, supply will be able to meet it quickly.

According to the International Energy Agency, U.S. oil production starts to ramp up at about $70 a barrel. Breaking through that level would require a supply response elsewhere (which OPEC has been unwilling to provide) or a rise in demand. As we’ll see, a demand response is simply not on the horizon.

Nobody is left to bail out sluggish demand

Two major countries have tended to impact oil prices the most over the previous decade: the U.S. and China. Neither are prepared to pick up the slack this time around.

As the world’s largest oil consumer, the U.S. sets to pace for demand. By 2040, however, the country is expected to have reduced consumption by a massive four million barrels per day. This represents a drop of more than 20% from today’s levels of 19 million barrels per day. The U.S. is not alone either. Combined, the E.U., Japan, and the U.S. will reduce oil demand by roughly 10 million barrels per day by 2040, offsetting nearly 50% of the demand growth from other parts of the world.

China, long the market’s biggest contributor of oil-demand growth, is set to plateau for decades. By 2040, Chinese energy demand is only expected to grow by 25% compared with a near 100% rise in the past decade alone. Even worse, the incremental demand should be met with renewables and natural gas, not oil.

Bottom pickers may get burned

Investors picking up shares of battered oil stocks shouldn’t expect a meaningful rebound for at least the next few years. The market supply-response ability should keep a cap on prices, while the demand story will be weak for decades.

If you still are interested in the energy space, stick with diversified businesses like Imperial Oil Limited (TSX:IMO)(NYSE:IMO) or Exxon Mobil Corporation (NYSE:XOM). As integrated oil operators, they have revenues streams that can thrive even in bear markets, such as pipelines or refineries.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Ryan Vanzo has no position in any stocks mentioned. The Motley Fool owns shares of ExxonMobil.

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