A Likely Inflection Point for Oil. It’s been said that, unfortunately for investors, the market doesn’t ring a bell at the bottom. Maybe not, but after crude’s 30%+ decline since October, today’s OPEC+ announcement for a 1.2 million barrel per day (mmbpd) cut in production could prove to be such a development for energy equities. Granted, an “all clear” scenario still largely depends on several key macro variables (tariffs, rates, Chinese GDP, etc.). Nevertheless, we believe today’s announcement might be the needed inflection point leading to some recovery in oil prices. Naturally, this should have positive implications for oil-related equities across the energy value chain, which have dramatically lagged the overall market in recent months.
OPEC’s Decision Highlights Both Its Relevance and Commitment to Supporting Oil Prices. With the dramatic growth in US shale production, as well as Qatar’s recent defection from the cartel, it’s been wondered if OPEC can still serve as a major influence on global crude balances and in turn oil prices. However, we believe this coordinated decision among traditional OPEC and non-OPEC nations (most critically Saudi Arabia and Russia) highlights the group’s continued relevance. Moreover, following its production curtailment two years ago to address bloated global inventories, this most recent cut reinforces both the commitment and need among OPEC+ member countries for healthy crude prices. (The IMF estimates that Saudi Arabia needs a $70-80/barrel Brent crude price just to balance its budget.) Maybe most importantly, today’s decision illustrates that this need for higher prices supersedes political pressures calling for contrasting actions (i.e., Trump tweets).
Increased Probability for Oil Tightness to Reemerge. Following OPEC’s decision two years ago, global oil inventories were dramatically reduced. This drawdown was only reversed in recent months as US oil output has surged and as Saudi significantly ramped production in anticipation of a major decline in Iranian exports due to the new US sanctions. The introduction of temporary waivers on those sanctions led many to believe that, without a cut in OPEC production, the world would be oversupplied by roughly 1 mmbpd in 1H19, a situation that would likely result in even lower crude prices (a la 2015). Conversely, we now believe that the latest OPEC+ cuts, combined with the eventual supply crunch from delayed Iranian sanctions (as much as another 1-1.5 mmbpd), could lead to the reemergence of supply tightness in upcoming months.
What’s Next for Energy Equities? A major frustration for energy investors has been that many stocks lagged oil prices on the way up earlier this year, but fully participated in the most recent correction in crude prices. This may have caused many investors to throw in the towel for a sector that now constitutes less than 6% of the S&P 500. Still, given the extremely depressed sentiment and the new OPEC tailwind, energy’s underperformance has also resulted in a favorable set-up for both existing investors and new money entering the sector, in our view. Moreover, the capital discipline/shareholder return approach recently embraced by many producers (and to be reinforced we expect when E&Ps soon announce 2019 budgets) enhances the attractiveness of the sector, especially at current levels. Therefore, much like the environment following OPEC’s 2016 decision, we think investors should take an unjaded view of a sector where equities in general seem poised for recovery.
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