Oil spiked recently due to geopolitical tensions and OPEC cuts, says portfolio manager Brian See.
Both West Texas Intermediate (WTI) and Brent oil had, as of May 2, fallen below their 52-week highs of US$69.56 and US$75.47, respectively, but they were trading close to those levels—on May 1, WTI closed at US$67.50 and Brent closed at US$73.38.
“When we first looked at these [OPEC] cuts, back in 2016 and into 2017, the cartel basically maintained their cuts for the year. And what they’ve decided to do is maintain their cuts for the broader part of 2018,” said See, vice-president of equities at CIBC Asset Management, in a late April interview.
What that’s done is “draw down oil inventories well below the five-year historical levels, and these were the levels that OPEC was targeting to bring the oil market more into balance.”
If this continues, “oil inventories are going to be somewhat undersupplied as we get into the second half of 2018, and that’s important because we’re entering a heavy demand period in the oil industry; it’s the summer driving season, and that’s when oil demand really takes off,” says See, who manages the CIBC Energy Fund.
His forecast, as of April 23, was that oil demand would be about 1.5 billion barrels a day. “That’s still a pretty robust demand number as we get into 2018,” he says.
Another factor he and his team are monitoring is OPEC compliance levels, which have been at “all-time highs,” See explains. “They’re trying to maintain a higher [oil] price to get ready [for the] Saudi Aramco IPO sometime here in 2018. Saudi has talked about a price range of at least US$80 per barrel, so look for prices to still be fairly constructive.”
CNBC reported that Saudi Aramco wants to “become the world’s most valuable company” as it prepares for the IPO that will likely occur later this year or in early 2019.
Impact of U.S. supply growth, conflicts
For U.S. supply growth heading into 2018, See and his team had expected “well over 1 million barrels.”
“There’s some potential risk for that number to be lower just because of infrastructure restraints in the Permian Basin, and that’s where the bulk of U.S. oil growth has taken place this year,” he says.
“Infrastructure has to be built in order to transfer oil out and in order for production to grow. So, given the constraints there, that actually sets up for a higher oil price as we go [further] into 2018,” he adds.
On top of U.S. developments, See is monitoring how overall geopolitical risk is resulting in a risk premium—or a return in excess of the risk-free rate of return—being added “into prices for the broader part of this year.”
For example, he says, consider the possibility of renewed sanctions on Iran, given “the U.S. has made no secret of trying to get out of this Iranian deal.” President Trump has threatened to withdraw from President Obama’s 2015 Iran nuclear deal, which allowed Iran to export more oil, by May 12.
Trump is remaining tight-lipped on his plans but reports say that oil markets expect the deal is coming to an end.
See also points to how Venezuela continues “to be in political, economic and social chaos, with the new government installed in that country. Production has fallen significantly as well; it used to be about 2.4 million barrels a day, and [it’s] now down to 1.5 million a day and continues to decline.”
That has removed supply from the market, he says, and supports current pricing trends.
There’s also tension between Syria and the U.S., and “ongoing conflicts between Saudi Arabia and Yemen,” he says. “For all of these reasons, the geopolitical risk premium [of] oil prices continues to be strong, and [we think] oil prices will continue to grind higher.”
Expectations for OPEC meeting
Ahead of the June OPEC meeting, See and his team have positioned the energy portfolios they manage to account for a higher oil price.
“That involves cycling into more commodity or torquier sectors such as [exploration and production] companies, which provide a better lift, or torque, to rising prices,” he says.
“We’ve added that in significant weight to the portfolios, and underweighted other investments such as mid-stream companies, which are more defensive entities,” he adds.
The goal, he explains, is to have “as much upside to light oil producers, and that’s what we’ve done.”
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