January 21, 2016
Schroders upgrades crude to “positive”
Geoff Blanning, Head of Commodities
Why now?
The price collapsed because global supply increased sharply in 2014-15 while demand growth sagged
– and more recently even stopped altogether. The Dollar’s super strength played a key role also. In the
past 3-6 months, supply growth has been sagging as a direct result of the lower price, but now it looks
like a strong bet that supply is actually going to fall, and fall sharply. As a result, the market is likely to
come into balance very quickly. As this happens, the price will recover smartly.
Mark Lacey and John Coyle have been reporting how very recently a number of companies have
announced further huge reductions in capital spending, lower production guidance or even shut-ins.
In 2016 to date, a very small sample of companies have announced a combined cut in production
guidance for this year of 160kbpd already, representing a 5-6% drop from last year. In the next few
weeks, as the rest of the companies report, we can expect similar announcements. From the initial
sample, we can conservatively estimate a combined cut in production globally for 2016 of 1.5-2mbd,
especially as the oil price is at least 20% lower than it was when the first companies reported. This
reduction should be easily adequate to balance the market.
Anecdotal evidence which points towards production declines is everywhere now. This is especially in the
US and Canada but notably in other parts of the world too. India, China, Kazakhstan and Nigeria are all
reporting declines. North Sea activity is coming to a standstill. Tanker rates from the Gulf have collapsed
recently as there has been a sharp drop in crude cargoes for February loading. Oil is being shipped to the
US from far and wide because the US domestic oil price is trading expensively to the rest of the world,
but the premium is being maintained. The futures market contango did not worsen at all as spot prices
recently swooned and in recent days it has been reduced. US E&P bankruptcies are soaring and the
financial tap is being turned off. The evidence is plain that US production is falling faster than the official
statistics report and the required oil is being “sucked” in from the rest of the world. This trend is going to
accelerate as US production drops precipitously in the next few months.
It’s not difficult to understand why companies are now reducing activity. Remind yourself of the chart
below kindly compiled by Citibank in late 2014.
Source: www.uk.businessinsider.com
Schroders upgrades crude to “positive”
EVERYONE is losing money now. Producers are much better off leaving it in the ground than
selling it for $27, especially as they know that storage facilities everywhere are pretty much
full. The market has been rightfully worried about “tank tops” but the price collapse has now,
very likely, done its job.
What can make the price fall further?
A collapse in demand. To some extent, this is already happening. Both Chinese and US
demand has slowed markedly, and it could continue (likely will, in my opinion). But my view
now is that the speed of supply response is overtaking the weakening of demand. We shall
see. A sudden surge in Libyan production would also hurt the price; let’s afford that a 25%
probability, given the security issues. A further surge in the Dollar would be a problem also,
for sure; my view is that the Dollar’s run is now likely fully played out, at least for now, given
the renewed turmoil in global stock markets and the weaker trend of US economic data,
both of which suggest the Fed will no hike again anytime soon.
Geoff Blanning,
Head of Commodities
– Head of Commodities; Energy
Fund Manager.
– Head of Emerging Markets Debt
and Commodity Group since
December 1998, member
of the Schroders Group
Management Committee.
– Geoff conceived and developed
Schroders Commodity businesses
from 2003.
– Investment career commenced in
1985 at NM Rothschild.
As a final note on Fundamentals, what if OPEC acts? This is a scenario completely dismissed
by the market currently. Pressure on the Saudis is now immense. Of course the likelihood of
the Saudis flinching may indeed be slim but just a suggestion of it today would be enough to
send the price up $5-10 at least. Risk in this market is heavily skewed for sure.
I will be writing an updated formal oil report in the next two weeks.
Our official Chart indicators for oil remain bearish, we looked at them closely yesterday. I
will argue, however, that from a Pattern point of view a very significant low is very likely in
place, or will be within a few days. I believe the sell-off from the mid-2014 high is finishing
now, based on wave counts. If this is indeed the case, the first upside target for crude is $38
(+36%), and after that $48 and $57. Strong supporting evidence, I believe, comes from the
performance of some of the oil stocks yesterday: they dropped sharply in the morning but
then closed very strongly, e.g. WPX was down 34% first thing but closed down only 6%,
which left a bullish candlestick. The relative strength of oil stocks versus crude is another
indication of a potential turning point. (And by the way, the gas stocks went up yesterday eg
Southwestern up 13%; the chart patter non this stock, I believe, is super-bullish. We already
has this stock rated as bullish chartwise. 50-100% upside looks easily achieveable.).
On Sentiment, again, our official indicators remain bearish but anecdotally we can now all
read the tea leaves. Just listen to any TV or radio commentator or Bloomberg video, or
read the papers. Everyone and his dog can now tell you why we are in a “lower for longer”
scenario, and I believe it is notable that even CEOs of major oil companies are now saying
the price won’t recover until second half 2016, a big change from their position 3 or 6
months ago. The IEA monthly report was widely quoted yesterday; “drowning in oil”, being
repeated everywhere. In summary, the big picture sentiment story is bullish; when our
shorter-term indicators turn it will be super-bullish.
To conclude, while more volatility can of course be expected, I would bet strongly that oil will
finish this month well above $30. I recommend at least a fully neutral position on oil with a
strong bias towards equities, which should be increased aggressively if the prices continue to
recover. Gas stocks ditto.
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