Global Energy - September Commentary

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In our ‘back to school’ report for global energy we consider the various factors affecting global oil supply and demand. We conclude that well-telegraphed and well-managed OPEC+ quota increases, combined with tariff risk-induced sub-trend oil demand growth, have put the oil market into short-term oversupply which is providing a cushion against elevated oil supply risks and Chinese strategic inventory demand. From 2026, a decline in US shale oil and a slowdown in new non-OPEC projects means our normalised assumption of $80/bl long-term Brent oil price is plausible, giving energy equities a free cash flow yield of nearly 10% and providing around 35% upside should long-term valuation metrics (based on return on capital employed (ROCE)) be restored.

Global oil demand growth resilient but sub-trend after ‘Liberation Day’

The IEA now estimates oil demand growth for 2025 of 0.7m b/day (to 103.7m b/day) with the non-OECD up by 0.8m b/day and the OECD down by 0.1m b/day, consistent with the IMF’s current global GDP growth forecast for 2025 of 2.8%. The ‘Liberation Day’ tariff announcement by US President Donald Trump in April caused most forecasters to reduce demand growth expectations by around 0.3m b/day and move to this sub-trend growth rate of less than one million barrels per day. Reassuringly, since then, demand growth expectations have remained broadly unchanged.

Across the oil complex, we have seen strength in the refining sector (as a result of refinery closures and maintenance) and continuing strength in aviation and petrochemicals demand. Unlike previous years, China (at +0.1m b/day) will not be a dominant driver of demand growth, as its passenger transportation sector sees increased electrification (50% of new vehicle sales are expected to be electric in 2025) and heavy trucking utilizes more liquified natural gas (China is estimated to have around 1 million LNG trucks). The rest of the demand growth is quite well spread across a number of countries and regions, including India, the Middle East, Brazil and the United States.

Global oil demand (m b/day)

Sources: IEA, DnB Carnegie, August 2025

Looking into 2026, the IEA forecasts that global oil demand growth stays at 0.7m b/day, consistent with an unchanged global GDP forecast of 2.8%. This will take global oil demand to a new peak level of 104.4m b/day, 3.7m b/day above the pre-COVID high of 100.7m b/day in 2019. As has been the recent trend, all of the growth will come from the non-OECD region with the OECD seeing a small decline. Looking further ahead, even with electric vehicles approaching 25% sales penetration this year, we continue to see global oil demand growing until around 2030, reaching a peak of somewhere between 107-109m b/day, and plateauing thereafter.

When writing at the start of the year about the prospects for oil demand, we placed strong emphasis on the current affordability of oil as a driver of demand growth and we believe that oil remains a ‘good value’ commodity. In real terms, we note that $70 oil today is equivalent in price to $44 oil in July 2014 – a period when oil prices were averaging over $100/bl – and that in terms of ‘real asset’ valuation, oil is at its cheapest relative price to gold since 1960 (apart from a very quick dip to a lower level in the middle of Covid in early 2020).

Based on Brent oil price of around $80/bl in 2025, we calculate that the world would spend around 2.7% of GDP on oil, below the 30-year average of around 3% and well below the 3.8% seen in 2010 when oil also averaged $80/bl. With oil trading in the high $60s/bl at the time of writing, the world is currently paying closer to 2% of GDP for its oil, putting today’s oil amongst the cheapest of the last fifty years.

The world oil ‘bill’ as a percentage of world GDP

Source: Bloomberg; Guinness Global Investors, Sept 2025

Low oil prices should have a positive effect on demand and, all things being equal, we would expect upward bias to the IEA’s oil demand estimate for 2025 and 2026 if oil prices remain at these lower levels. The other effect of lower oil prices should be lower future oil supply.

Non-OPEC oil supply showing price related weakness; US shale to decline during 2026

The IEA estimate for non-OPEC supply growth in 2025 has moderated by 0.4m b/day since late 2024, with an initial growth forecast of 1.8m b/day shrinking to 1.4m b/day currently.

The key variable within this has been US shale oil supply, where production typically lags oil prices by around nine months. Having been the dominant force in non-OPEC supply growth over the last 15 years, US shale oil is likely to peak at the end of 2025 (the US Energy Information Administration (EIA) estimates 13.6m b/d of US oil production in December 2025) and then to see a shallow decline in 2026. While the EIA expects growth of 0.1m b/day on average in 2026 vs 2025, this masks the fact that US oil production will exit 2026 around 0.4m b/day lower than it started the year.

Capital discipline continues to be the main driver of lower activity levels in US shale oil, with compensation incentives for E&P management teams now being driven by profitability, cash flow and operational metrics rather than growth or resource-oriented metrics. Easing US oil field regulations, the availability of federal lands and the ‘drill baby drill’ mantra from the President do not appear to be bringing a change of strategy to this part of the oil industry.

US oil production, including estimates to end 2026 (m b/day)

Source: DNB Carnegie, EIA, August 2025

Some pockets of non-OPEC growth are appearing in 2025. Canada is likely to grow around 0.1m b/day while Guyana pursues its growth from zero in 2019 to nearly 1m b/day at the end of 2025 and Brazil reaches new peak production levels with growth of 0.35m b/day in 2025. The overall growth trend likely persists in 2026 (IEA estimates 1.2m b/day non-OPEC growth) but the effect of lower oil prices and a slowing slate of new project developments could see more muted production growth from 2027 and beyond.

OPEC pursuing market share growth, but actual supply growth not as great as feared

OPEC+’s actions are the key reason for weaker oil prices in 2025. In March, OPEC+ announced a plan to unwind voluntary production cuts from April at a rate of 137k b/day per month, thus taking 18 months to unwind a total of around 2.5m b/day of voluntary production cuts. In April, the group decided to carry out a triple hike (implying 411k b/day) for May which and this was subsequently repeated in June and July and then concluded with two quadruple hikes (548k b/day each) in August and September. Thus, OPEC+ unwound its production cuts of 2.46m b/day in just six months, compared to the earlier planned 18 months. We see a number of reasons for the unwinding of these OPEC+ voluntary cuts:

• OPEC sees the world oil market as being much tighter than the other main commentators (the IEA and the EIA) and therefore sees the need for greater supply flexibility. OPEC’s oil demand growth forecasts for 2025 and 2026 of 1.3m and 1.4m b/day are around double those of the IEA while its non-OPEC supply growth of 0.8m b/day in 2025 is 0.4m b/day lower than that of the IEA.
• Core members of the OPEC+ group (e.g. Saudi and Kuwait) are attempting to bring overproducers (e.g. Kazakhstan, Iraq) into line, in addition to maintaining market share at non-OPEC’s expense.
• OPEC+ sees a heightened level of geopolitical oil supply risk, such as i) the threat of lower Russian production as the US sets large tariffs on Indian imports of Russian crude oil and ii) lower Iranian oil exports as the US and Europe step up efforts to slow Iranian nuclear development.

Oil exports from the key OPEC countries (Saudi, Iraq, UAE, Kuwait) for July (latest data point) were up only 0.2m b/day versus the first quarter. This fuels questions about OPEC’s ability to increase its oil exports and, while quotas have been increased by around 2.5m b/day, we expect that only around 60% of this will actually be seen as increased supply. Numerous OPEC+ countries are either already overproducing relative to quota or they are struggling with having enough spare capacity to increase their production. Major contributions will likely come from Saudi Arabia and UAE with smaller contributions from Kuwait and Algeria, while most non-OPEC members appear to have already been producing at full capacity.

OPEC+ continued to stress that its supply strategy could be amended at any time, should market conditions require it.

OECD inventories have barely moved as China has built strategic stockpiles

In line with IEA, we see that the oil market has moved into oversupply in 2025 (around 0.7m b/day oversupplied so far this year) and we believe that this will continue, but moderate, through 2026. This oversupply view is in stark contrast to OPEC’s opinion that the market remains in undersupply of around 1m b/day in both years.

Despite the oversupply, OECD oil inventories – which are instrumental in Brent and WTI oil price formation – are broadly flat on a year-to-date basis and are down on a year-over-year basis. It therefore appears that China has been tactically building strategic inventory during this the period of lower oil prices.

OECD total product and crude inventories, monthly, 2010 to July 2025

Source: IEA Oil Market Reports (August 2025 and older)

Oil prices already reflecting a well-telegraphed surplus market

The oil market is heading for a surplus in coming quarters that is well anticipated. Oil prices have weakened into the event (spot oil prices are down around 10% to $68/bl while long-dated prices have been broadly flat) in an ordered manner. In this respect, OPEC have been keeping the market informed and are allowing lower prices to initiate a rebalancing of supply and demand that should start to have an effect from later in 2026.

We do not see this as a change of strategy from OPEC. Saudi continue to lead the group, and they seek, as they have done for many years, to balance the market at a sensible price that allows them to maintain market share. We see Saudi as a rational and intelligent operator in the oil market, targeting an oil price that closes their fiscal deficit (according to the IMF, they require $91/bl to break even this year) but does not stress the world economy. Saudi’s sweet spot for oil, therefore, appears to be in the $80-90/bl range. Defending an $80 oil price in 2025 would be less aggressive in real terms as the group’s actions in 2006-2008 when they defended a nominal price of around $60/bl (c.$110/bl in today’s money).

Defending $80/bl oil with sufficient market share has proved to be difficult to achieve in early 2025, hence Saudi’s actions to rebalance the market. Looking ahead, spot oil prices over the next 12 months will be volatile, and with non-OPEC supply growth again next year, it is plausible that the spot oil price dips to the $60/bl level for a period. However, we maintain our long-term oil price average of $80/bl, a price that incentivises sufficient oil supply over the next few years while being ‘good enough’ for OPEC+ balance sheets.

Valuation of energy equities

Moves in energy equities so far this year have lifted the price-to-book (P/B) ratio for the energy sector at the end of August 2025 to around 1.7x, versus the S&P 500 trading at 5.3x. On a relative P/B basis versus the S&P500, therefore, the valuation of energy equities now sits at around 0.33x (down from 0.36x at the end of August 2024), and still more than two standard deviations below the long-term relationship.

P/B of energy sector versus S&P 500

We keep a close eye on the relationship between the P/B ratio for the energy sector and return on capital employed (ROCE), which historically shows high correlation.

ROCE for the Guinness Global Energy portfolio in 2025 (assuming an average Brent oil price of $70/bl) will be around 9%, we think, a little below mid-cycle ROCE, which we peg at around 11%. However, current valuation implies that the ROCE of our companies will stay at about 4% on a long-term basis. If ROCE remains at around 9-10% and the market were to pay for it sustainably, it would imply an increase in the equity valuation of around 30-35%:

Sources: Bloomberg; Guinness Global Investors, inc. estimates; August 2025

The higher ROCE is being supported by robust free cash generation. Assuming an average Brent oil price of $70/bl in 2025, we estimate the average free cashflow yield of our portfolio, after capital expenditure, to be around 8.4% and note that the 2025 estimated gross dividend yield of the portfolio currently sits at around 4.8%. Fixed dividends in the portfolio have generally been growing and have ample room to run further, given the high free cashflow yield. At our long-term oil price assumption of $80/bl, the average free cashflow yield rises to over 10%.

To consider valuation another way, we are often asked what oil price is implied in the portfolio, as a barometer of the expectation priced into the equities. At the end of June, we estimate that the valuation of our portfolio of energy equities reflected a long-term Brent/WTI oil price of around $67/bl. If the market were to price in a long-term oil price of $75/bl, on a one year forward view it would imply around 30% upside while there would be around 60% upside at a long-term oil price of $85/bl Brent (which is equivalent to $55 in 2007 prices):

Upside/downside for Guinness energy portfolio (1-year forward view)

Source: Guinness Global Investors, August 2025

In summary, at $70/bl Brent in 2025, our portfolio continues to trade at a significant valuation discount to the broader equity market, despite high shareholder return yields. We see good confidence that dividends can be maintained and supplemented by share buyback programmes, driven by a free cash flow yield of over 8% for the portfolio, which rises to over 10% at our long-term oil price assumption of $80/bl.

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