BLACKROCK INVESTMENT INSTITUTE

Opportunities as oil nears bottom

03/dec/2018
By BlackRock

Key points

  1. Oil prices could be close to a trough and we see selected opportunities emerging ahead of a recovery.
  2. The US and China put further tariffs on hold for 90 days. We see this boosting risk assets in the short run.
  3. Economists expect strong US non-farm payrolls growth in November, and the data will offer a key signal ahead of the Fed’s December meeting.

Opportunities as oil nears bottom

Oil prices are in a bear market. Both Brent (the international price benchmark) and WTI (the American benchmark) have declined more than 30% from 2018 highs. Where does oil go from here? We see oil prices near their nadir and a potential price recovery opening up opportunity for investors.

Chart of the week

Crude oil price and OPEC production curbs, 2016-2018

Chart of the week

Past performance is not a reliable indicator of current or future results.
Source: BlackRock Investment Institute, with data from Thomson Reuters, November 2018. Notes: The chart shows cumulative Brent oil price performance starting 60 trading days before three prior OPEC production curb announcements and the bloc’s upcoming meeting. The dates reflect an OPEC cut on Nov. 30, 2016, and cut extensions on May 25 and Nov. 30, 2017. The orange line leads into the next OPEC meeting on Dec. 6.

One reason oil prices may be near a bottom: production appears set to decline after oversupply concerns contributed to the recent rout. The Organization of the Petroleum Exporting Countries (OPEC) and its partners are expected to cut production at their meeting this week in an effort to help stabilise prices. OPEC curbs since 2016 have had that effect, as shown above. Brent popped on news of the first cut in November 2016 and stabilised with curb extensions. We estimate a cut of roughly 1.2 million barrels per day this round. This is in the middle of the consensus range, as we see US production growing slightly less than some market participants, but enough to help manage oversupply, in our view. Pressure from the US government to avoid high prices may limit the size of the cut and could inject some downside, however.

Where does oil go from here?

Global oil inventories saw the largest quarterly increase in three years last quarter. Oversupply concerns are poised to fade, however, with the potential OPEC cut, expiring Iranian sanction waivers and production decreases from many US producers amid lower oil prices. Yet the recent selloff wasn’t only about supply. Other contributors: Fears of weakening demand amid worries about a global growth slowdown have played a role, while price declines have been exacerbated by market participants unwinding long positions built on earlier speculation of higher oil prices, evident in US Commodity Futures Trading Commission data. Our BlackRock GPS shows solid, albeit slowing, global growth, which should underpin near-term demand and market sentiment. And refiners’ recent weak demand is not concerning, in our view, as many refineries were shut down for seasonal maintenance.

Energy equities and debt have suffered along with crude to varying degrees. Energy stocks underperformed spot oil prices at the beginning of the selloff but recently have declined only about half as much. Yet we believe the recent price reset may offer an attractive entry point as capital discipline and balance sheet management remain priorities for many energy companies. We see some opportunities for investors willing to stomach volatility. Within energy equities, we prefer midstream firms focused on oil storage and transportation. Their high-yielding nature may offer a buffer in a risk-off environment. We also favour oil field service companies longer term, as US shale is needed to help meet global demand in the 2020s. In fixed income, we prefer midstream companies in the investment grade space and selected high-quality exploration & production firms.

More broadly, global equities appear less sensitive to oil price fluctuations than in the past. An oil price rebound driven by higher demand amid above-trend global growth may be good for risk assets. A supply adjustment that puts a floor under oil prices may not have as widespread an impact. Stabilisation in the oil price should help global markets going forward, but we expect there will be winners and losers, particularly in some emerging markets. Markets in oil-exporting countries could benefit from stabilising prices, though a big bounce could hurt markets in importing countries with current account issues.

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  • Federal Reserve Chair Jerome Powell said he sees US interest rates as “just below the broad range of estimates" of neutral. Risk assets rallied, as markets interpreted the comments as a sign that the pace of future policy tightening in the US may be slower than previously anticipated. Equities rose, led by US and tech stocks and the momentum factor, and US Treasury yields fell.
  • US President Donald Trump and Chinese President Xi Jinping agreed to work together to resolve their trade dispute and put further tariffs on hold for 90 days. We see this outcome boosting global risk appetite in the short term.
  • The US core Personal Consumption Expenditures index rose 1.8% in October from a year earlier, below the 1.9% growth expected and the lowest level since February.

 


 

  Date: Event
Dec. 3 China Caixin and US ISM Manufacturing PMIs
Dec. 5 US Fed Beige book, Fed Chair Powell will testify before the US Senate’s Joint Economic Committee
Dec. 6 OPEC meeting; US trade data, factory orders
Dec. 7 US employment report; German industrial production, German CDU party convention (Dec. 7-8)

Markets will be looking to Friday’s employment report as a key signal ahead of the Fed’s Dec. 18-19 meeting, especially in light of the initially dovish interpretation of Fed Chair Powell’s comments last week. Consensus expectations are for a solid report showing more than 200,000 jobs added, following a strong print of 250,000 jobs gained in October. Average hourly earnings are expected to increase 3.1%, in line with October’s report. Such data would confirm a US economy still operating at a very solid level.

Managing Director, is Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active ...

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