Why We Are Positive On Oil

Recent developments

Having reached a 4-year high in early October ($86 for the Brent) amid speculation that OPEC’s supply would not be sufficient to offset the fall in Iranian exports when sanctions started to kick in on 4 November, oil prices corrected significantly as worries intensified over weaker demand in 2019, a supply glut due to softer restrictions on Iran and record production in Saudi Arabia. 

Why the weakness in oil prices should be temporary

1.       Anxiety over weak demand in 2019 seems exaggerated.  There is little doubt that oil prices above $80 per barrel are having a negative impact on demand growth especially in emerging countries.

2.       OPEC, Russia and associate countries are likely to extend their production restrictions sooner or later. Saudi Arabia’s Energy Minister, Khalid al-Falih, said that he was expecting weak oil demand in January and that the Kingdom would respond accordingly in a bid to appease concerns in the global market. But this statement did not prevent a further collapse of crude oil prices.

The market seems to assume that the Saudis will not be able to defy Trump’s desire to lower oil prices after the White House supported Prince Mohammed bin Salman (‘MBS’) following the killing of Jamal Khashoggi, a prominent journalist from The Washington Post.

The attitude of Russia is still not clear. Russia hinted that it would be happy with a price of $70/barrel. The OPEC, Russia and associate producers will meet in Vienna on 6 December.

3.       US shale oil production is price-sensitive. If WTI prices remain at around $50/b, the number of active rigs would logically decline in the coming months, hence preventing US oil production from accelerating at the same rate as in the first half of 2018.

4.       An increase in oil stockpiles is usual before the winter. The increase in US stockpiles above their 5-year average was one of the factors triggering the recent price plunge.

5.      The medium-term outlook is bullish due to the lack of investments in traditional oil fields. Without investments, the production of traditional oil fields declines by 6-7% per year on average.  The last three years have been characterised by weak investments both in existing oil fields and in prospecting.

We upgrade our rating on oil from neutral to positive

Medium-term forward prices (2021-22-23) have also declined and the forward curve is now relatively flat, suggesting that market fears over the supply glut might persist for a while. This does not augur well for a V-shaped recovery.

The remarkable and simultaneous increase in production in the United States, Saudi Arabia and Russia (the three main oil producers) should appease supply woes for a while.

Yet we must keep in mind that the equilibrium between supply and demand is shaky. The United States might remain committed to reducing Iranian exports to zero from 1.8 mb/d  today and there are concerns over the stability of production in Libya, Nigeria and Venezuela.

We are convinced that the present weakness in oil prices will not last long. So it offers a good investment opportunity. Our fair value range for the coming months is now $65 to $75 per barrel.

We maintain a positive stance on energy stocks

A Big Market Sell-off: Is this the End of the Cycle?

Energy stocks have suffered from the recent downturn in oil prices. After a strong performance in 1H18, the sector has underperformed by 6% in Europe since the beginning of October. Capex discipline is still a positive factor for the sector. It should support cash flows while valuations appear attractive. 

Since the recent sell-off, the sector has de-rated significantly, and is back at attractive levels. In Europe, the P/E ratio is 10x below its 2-year average. The dividend is not at risk in our view, as it is backed by significant free cash flows at the current level of oil prices.

We thus remain confident in the sector and favour oil majors in Europe and in the US. We are however neutral on oil services due to their riskier profile.