The resources sector is set for a bumpy ride in the near term, with companies unlikely to work through the current period of oversupply, says Morningstar.
In a recent Morningstar report, Outlook for Resources, it was argued that short-term pain in the resources sector will to continue as "all signs point to a brutal near term".
“Current supply imbalances are such that, as of today, oil production is effectively running two years ahead of demand,” the report said.
“Declining US oil production during the next several quarters will help reduce global oversupply, but in our opinion, that alone cannot quickly fix the current global imbalances.”
Morningstar said that if the market is to approach normalcy before 2017, Saudi Arabia must cut production, or alternatively, global demand must increase beyond 95 million barrels per day. The report also said a geopolitical event in another oil-exporting nation would have to occur.
“Without one or more of these events occurring, then ‘lower for longer’ looks to be the unavoidable near-term course for the industry,” the report said.
"While we forecast oil prices recovering in the long term, 2017 is still reasonably far off and considerable volatility is possible in the interim.”
September output in the US is expected to come in six per cent lower than peak levels reached in March and April this year and Morningstar expects US oil production to continue to fall, declining by eight per cent in 2016.
“It is plausible that oil ranging between US$40 and US$60 per barrel for the next one to two years could ensure the industry takes sufficient measures to reduce supply,” Morningstar said.
“But if global production continues to surprise to the upside – as it has for most of 2015 – or if demand growth slows, prices could easily test new lows before the downturn ends,” the report stated.
According to Morningstar, the resources sector overall remains undervalued. Energy stocks trade at "fair value", while materials are at a 10 per cent discount.
“The main pockets of value are in the large mining stocks, such as BHP Billiton and Alumina, both of which are best ideas.”