Etikett: Oil rally

Oil rally has legs

ETF Securities Oil rally has legs Many OPEC members are likely to cut back on supply. Iran is unlikely to raise production to pre-sanction levels.Oil rally has legs

ETF Securities Commodities Research: Oil rally has legs

Summary

  • Market balance can be achieved in 2016 as demand grows and supply declines.
  • Many OPEC members are likely to cut back on supply. Iran is unlikely to raise production to pre-sanction levels.
  • To meet future demand for oil, prices will have to rise further.

Toward market balance

Brent has risen to above US$43/bbl from below US$28/bbl in January as investor optimism for oil has markedly improved. We believe the gains in price are sustainable and not just driven by speculative gains.

Based on IEA’s demand forecasts, we are likely to be in a global oil supply deficit by Q3 2016, even if we assume that supply does not fall from Q1 2016 levels.

Supply however has been declining from non-OPEC sources. A large part of the decline in production has come from the US where the lagged effects of cuts in oil rigs in 2014 and 2015 are substantially biting into supply. By December 2015 global oil CAPEX was declining at a rate of 32% year-on-year. Although some large projects – too far into development to reverse – are still coming on-stream in countries like Brazil and Russia, most non-OPEC producing countries should see declining production.

Will OPEC supply also decline?

While OPEC has failed to coordinate to freeze production, except for Iran, most of its members are already cutting back on production and we expect a continuation of this trend.

Iran seeks to bring its production back to pre-sanction levels (3.7 million barrels per day) and so has increased its output from 2.8 million barrels per day in Q1 2015 to 3.3 million barrels per day in Q1 2016. But we think that Iran will struggle to raise production further than 3.5 million barrels per day by 2017, as it would require a significant infrastructure build, which will be difficult to achieve while sanctions are only part-lifted and oil prices remain relatively weak.

Under the strain of low oil prices, OPEC countries have been cutting back on fiscal expenditure. The current account of the Gulf Governing Council and Algeria is expected to reverse from a comfortable surplus to a deficit of about 8% of GDP in 2016. We believe it will be very difficult for OPEC countries to invest in any additional capacity that would allow for a significant increase in oil production under such conditions.

By 2017 OPEC spare capacity is likely to fall to 1.57 million barrels per day, down from 3.98 million barrels in 2010. With reduced spare capacity, unplanned outages will be difficult to deal with without spike in prices. Unplanned outages in Saudi Arabia and Kuwait appear to have been increasing lately.

Electricity outagesi, hyperinflation and forced worker holidays could see oil outages pick up in Venezuela too.
In its “Vision 2030” plan, Saudi Arabia has articulated that it wants it economy to be less reliant on oil. If the country follows through with its plans, the country may not seek to expand production capacity as aggressively as it has done in the past.

Inventory concerns overstated

US crude oil inventories have risen strongly since the collapse in oil prices in November 2014. However, with production declining in the US, we believe that constraints on storage will be alleviated. Storage is likely to have reached 70-80%ii of capacity in the US, but with the ability to export US oil and the development of storage capacity in other countries, we believe the market concerns around storing oi in the US are overstated.

China in particular has been investing in building storage capacity. China built 200 million barrels in strategic petroleum reserves (SPR) between 2006 and 2016. According to the IEA, in 2016 alone they will build 110 mb of SPR (and a further 35 mb of commercial).

Meeting future demand

Current global oil demand is approximately 95 million barrels per day and we believe that it could rise to 98 million barrels by 2020. Only 80 million barrels of this can be met by currently producing fields. To unlock the remaining 18, oil prices will have to increase. The break-even for tight oil for example is estimated to be US$65/bbl.iii

i Venezuela is highly reliant on hydroelectricity and low water-levels have led to shut-ins.
ii The last data release for storage capacity was as of September 2015. Since then more capacity has been built, but we will only get EIA data on this at the end of May 2016 for March 2016.
iii The line in the chart represents the weighted average break-even oil price i.e. the Brent oil price at which net-present value is zero using a real discount rate of 7.5%. The bands around the break-even represent the 60% confidence interval. Producing fields have a low break-even due to CAPEX already sunk and cheap Middle East oil.

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Will oil rally in 2016?

Will oil rally in 2016?

Will oil rally in 2016? Capital markets started the year against a backdrop of a strong rise in risk aversion. Over the last few weeks, fears concerning the health of the US economy, the future of Chinese growth and the collapse in oil prices have pushed investors to protect portfolios and continuously sell risky assets.

The price per barrel is suffering from weak global trade and Iran’s return to the group of oil-producing countries, but also from the particularly mild climate since the end of last year. Accordingly, financial markets are reducing risk, taking this fall in the oil price as the self-fulfilling prophecy of a sluggish global economy lacking momentum. Strong correlation is thus building between equities (including those in the eurozone) and energy commodity prices.

Chart 1
Correlation between equity and energy commodity

(Click to enlarge)

Clearly there are devastating consequences for oil-producing countries, as they watch revenue collapse and face investors withdrawing capital in anticipation of lower rates, on the grounds that emerging central banks will have to introduce more accommodative policies to support the clear slowdown in local activity. Here, too, the correlation between emerging market currencies and the price of Brent is increasing, with each additional fall in oil prices translating into a stronger US dollar versus emerging currencies.

Chart 2
Brent & dollar vs. emerging currencies

(Click to enlarge)

Chart 3
Currencies: US Dollar vs. Euro & emerging currencies

(Click to enlarge)

On the stock market this continuous fall in emerging currencies is penalizing equities for which performance depends, to a large extent, on the change in parity versus developed market equities. In fact, the deterioration in current account balances in emerging countries is creating economic difficulties for regions watching the price of their dollar imports rising constantly. The dollar is no longer rising versus the euro but continues to rise versus emerging currencies, which shows that the later are indeed weakening.

Chart 4
Brent spot price & US rig count

(Click to enlarge)

Is there any hope of an end to this phenomenon this year? We believe that oil may have bottomed out, or that even if it falls a bit further, there is light at the end of the tunnel. In fact, Saudi Arabia’s strategy to undermine US shale oil is working. Even if this industry will not disappear thanks to its high flexibility (the rig count is declining [see chart] but deep offshore drilling is under greater threat at these price levels), US banks may demand a higher cost of capital (defaults should at least rise towards 6% in the US high yield energy segment this year) and the regulator may require a more conservative valuation of reserves in the business models of alternative producers.

From here on in, voices has already raised to this effect. Concerted action could resume within OPEC in order to get better control of production. Indeed, at these prices, several countries will be tempted to buy social peace by rebalancing their budgets with an income boost.

So we can start to think about implementing investment strategies for this new situation. Directly purchasing commodities is not the only option. For an indirect play, energy sectors in US and European majors could be considered, break-even inflation points are at their lowest in the US today and could benefit from tensions with a barrel price which will initially return to around $40. Similarly, developed currencies linked to oil, such as the Canadian dollar (see chart), may also offer the opportunity to play this theme of the end of a great bear cycle for energy.

Chart 5
Brent price & Canadian dollar (vs. $)

(Click to enlarge)

Franck Nicolas
Head of – Investment and client solutions

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Late Week Rally Subject to Correction?

Late Week Rally Subject to Correction?

ETFS Multi-Asset Weekly Late Week Rally Subject to Correction?

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Late Week Rally Subject to Correction

  • Highlights Oil rally continues to defy rising inventories.
  • Growth data boosts confidence.
  • Riksbank enters the currency battle, pressuring SEK lower.

While improving economic landscape, particularly in the Eurozone economies, and less focus on political risk to the region have underpinned some lift in investor sentiment, uncertainty over stretched bond and equity valuations lingers. Rising volatility across asset classes is likely to keep investors somewhat cautious and with central banks continuing to surprise markets with more aggressive stimulus, gold in particular looks well-placed to benefit, especially for non-USD investors. With Greek debt discussion to resume this week, we could see some of the recent optimism dampen.

Commodities

Oil rally continues to defy rising inventories. Oil rallied sharply on Friday (after the data cut-off for this report) as the market becomes increasingly optimistic about tightening supply. For now however, inventories continue to rise. A cut in production will be required to sustain current prices. The spread between Brent and WTI benchmarks has widened to the highest since September 2014, with Brent leading the gains. Natural gas and heating oil also gained 4.1% and 5.1% as a cold weather snap in the US North East boosted demand for heating energy. Cocoa rose 6.5% as a lack of rain in West Africa threatens to spoil the flowering for the April-September ‘mid-crop’ period. Industrial metals were pressured by concerns over weak global growth, although the better-than-expected GDP reading from the Euro area (in particular Germany) on Friday, could reverse some of those losses.

Equities

Growth data boosts confidence. The S&P 500 rose to an all-time high while European bourses rallied as Euro area GDP defied doomsayers’ expectations of collapse on Friday. However, volatility is also rising. The EURO STOXX 50® Investable Volatility Index gained 2.6% last week after having fallen more than 16% in the past month. Meanwhile strong lending data helped the MSCI China A-Share index recover 2.1% last week, as the market has become more optimistic about the scope of policy easing on increasing credit intermediation. With the week-long Chinese New Year holidays commencing on 19th February, we expect activity to be subdued. Gold miners lost some of their recent momentum, with performance tracking the gold price lower. The DAXglobal gold mining index fell 5.8%.

Currencies

Riksbank enters the currency battle, pressuring SEK lower. In another policy surprise, the Swedish central bank cut rates last week, sending the Krona lower against major G10 currencies. The governor of the Riksbank noted that additional measures targeting the currency cannot be ruled out and we expect SEK to remain under pressure. With global economic activity improving, the USD experienced a modest sell-off last week. Despite USD positioning appearing somewhat stretched near record highs, investor sentiment remains fragile and we expect the USD to remain well supported in the near-term. The focus for investors will be on Greek debt negotiations alongside central bank policy, with the Bank of Japan holding a policy meeting and monetary policy minutes scheduled for released from the Federal Reserve and the Bank of England. In light of recent aggressive moves from central banks in terms of stimulus and rising volatility, if there is any pause in the support being provided, a sharp rally could ensue, with JPY one likely candidate this week.

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