According to Schlumberger Limiteds CEO, the Oil Market Isnt as Unbalanced as We Think

By Markets Fool.com

Continue Reading Below

Photo credit: Flickr user Nestor Galina.

The world's top oil-field service company, Schlumberger, recently reported fourth-quarter results. The results were surprisingly good given the dour state of the oil market.CEO Paal Kibsgaard also used the company's quarterly conference call to make the surprising argument that the oil market is notas out of balance as the market seems to think.

Supply and demand
After spending the first 20 minutes of the call discussing the highlights of the quarter, Schlumberger's management team turned to its outlook for the year ahead.

Kibsgaard started off by looking at the global economic outlook for 2015, noting that "GDP growth rate softened somewhat in the fourth quarter, but that 3% growth [in 2015] is still projected to be higher than 2014, confirming that the global recovery remains intact, and as a result demand for oil is again expected to increase by around 1 million barrels per day in 2016."

Kibsgaard then turned his attention to the supply side of the equation: "Looking at the supply side, the growth in global oil production capacity of around 1 million barrels per day over the past year matches the growth in demand. So the overall oil market is still relatively well balanced from a capacity standpoint."

Continue Reading Below

This statement goes againstthe prevailing viewpoint that the world is oversupplied with oil. This supply glut has causedthe dramatic drop in oil prices over the past few months. However, Kibsgaard's view is that this is solely a temporary glut.

The problem is the marketed supply
Kibsgaard pointed out that OPEC shifted its policy from protecting price to protecting market share as U.S. producers were flooding the market with oil and had no plans to slow down. However, he sees it as a self-correcting situation:

The dramatic fall in oil prices is instead a result of higher marketed supply in the second half of 2014 from North America and also from OPEC who have shifted focus from protecting oil prices to protecting market share. In response to the falling oil prices, the industry is currently in the process of significantly reducing E&P investments which will lead to a reduction in supply as declining rates impact current production capacity and lower exploration and development activity delay supply additions.

Basically,Kibsgaard argued thatcurrent production capacity is enough to meet projected demand, but the existing marketed supplyoutstrips demand. With OPEC unwilling to pull back on production, the industryhas been forced to quickly reduce investments to reduce supply. However, the CEO alsopointed out that the industry had been cutting back on investments well before prices began to plunge.

Kibsgaard said he sees this leading to tightening supply: "In a scenario of continuing economic growth and increasing demand for oil, the lower E&P investment levels will lead to a tightening of the oil market, with the first indication being the reduced production capacity in the international markets in 2014 following a year of flat E&P investment."

With the industry's spending in 2014 flat from 2013, it was alreadyon pace to tighten supply well before the impact of reduced spending this year. This suggests the oil market could move from the current marketed oversupply to a capacity undersupply situation bylate next year.

Investor takeaway
The oil market tends to ebb and flow with supply and demand. Right now, marketed supply is ahead of demand, but it shouldn't stay that way for too long. Demand is expected to grow due to economic expansion, while international supply was already on pace to peak in 2014 as oil producers kept spending flat. This all meansthe oil market could rebound over the course of the next year as oil supply capacity comes out of the market.

The article According to Schlumberger Limiteds CEO, the Oil Market Isnt as Unbalanced as We Think originally appeared on Fool.com.

Matt DiLallo has no position in any stocks mentioned, but owns plenty of other oil stocks, which is why he's paying close attention to what Schlumberger has to say about oil. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.