The oil price is likely to recover at some point in 2016 from its current extreme lows, according to FE Alpha Manager Mark Barnett, manager of the Invesco Perpetual Income and High Income funds.
The fall in the oil price continued to dominate headlines this year following its rout in the second half of last year as prices reach near a seven-year low.
Today, the oil price is $37 per barrel which represents a 69.27 per cent fall since June 2014, according to FE Analytics.
Performance of index since 27 June 2014
Source: FE Analytics
Until recently the price had stabilised to around $45 in oil accelerated last week following a painfully indecisive OPEC meeting, says Russ Koesterich, BlackRock’s global chief investment strategist.
“The gist of the problem continues to be a glut of supply. U.S. drillers are becoming more and more efficient.”
“Despite a greater-than 60 per cent collapse in the U.S. rig count, domestic production is down less than 5 per cent from its recent peak.”
Barnett, who holds BP is expecting some recovery next year. He said: “On the recovery side, the oil market is widely expected to tighten by mid-2016 as demand appears to be robust whilst supply growth is being curtailed.”
“Although notoriously difficult to predict, this will be relevant not just to the fund’s holding in BP but to other energy –related stocks including Centrica, Drax and SSE, all of which have been affected by price weakness across the whole energy complex.”
Oil last had a major rout in 2008 with its price recovering from December 2008 to March 2011. Over this time a cadre of energy funds all soared, performing in the top decile of all funds in within the investment association.
These were Guinness Global Energy, BlackRock GF World Energy, Investec Global Energy, MFM Junior Oils Trust and Schroder ISF Global Energy.
Performance of funds December 2008 to March 2011
Source: FE Analytics
Our data shows all the funds beat the wider equity market over this period as show in graph below with Schroder ISF Global Energy doubling the FTSE All Share index’s gain and Angelos Damaskos’ MFM Junior Oils Trust almost tripling it.
Performance of funds index since 27 June 2014
Source: FE Analytics
The $10m fund has the second highest beta to the index behind Guinness Global Energy of all the vehicles, meaning it has risen and fallen harder and faster than the wider equity market over the past five years.
Top holdings include Far, Carnavon Petroleum, Serica Energy and Victoria Oil and Gas.
Damaskos, who has headed the fund since 2004, argues a key driver for the oil recovery will the current low price hitting the state finances of key oil producing countries such as Saudi Arabia and Russia hard.
As these two carry have substantial power within the Organisation of the Petroleum Exporting Countries [OPEC].
“Overproduction by fiscally challenged regions, including Saudi Arabia, might be viable as a short-term income-boosting measure but the longer term ability to produce will be dictated by capital spending,” he said.
“It is crystal clear to us that in the medium to longer term, supply of oil is due to contract sharply and not only from the highly elastic North American shale projects.”
“Substantial damage is being inflicted on longer term, high marginal cost projects that are now being delayed or cancelled altogether.”
He adds that at the same time global demand for oil is continuing to grow.
“The IEA projects that the world will need a further 1 million barrels of oil per day in 2016 and that demand growth will continue at a steady rate for the foreseeable future. This makes sense given the structure of the global economy and the rapid rise of living standards in the most populous regions.”
“Once the current oversupply is corrected, the pendulum will swing the other way inexorably as the capital starvation of the oil industry becomes the heaviest impediment to increases in production.”
Roberto Cominotto, manager of GAM’s JB Energy Transition fund, warns a supply shock (which would send prices rocketing up) could also be brewing due to geopolitical risk.
“A break-up of the state of Iraq is only a matter of time, in my view. While Kurds, Sunnis and the Shiite-led government in Baghdad are currently focusing on their fight against ISIS, secessionist forces are increasing in Kurdistan and the Sunni regions,” he said.
“Earlier this year, the Kurdish semi-autonomous region started exporting oil directly, bypassing the central government in Baghdad against its will.”
“Kurdish leaders have also been lobbying in Washington for support of an independent state. A break-up of the country would probably create more instability and border disputes within Iraq, but also in the Kurdish territories in Turkey and Iran.”
He says the most recent OPEC meeting, where it confirmed its strategy for the next year of keeping oil production as high as possible to push producers with higher costs out of the market, will keep oil prices low for time being.
“However, we expect a price increase in the second half of 2016. While global demand continues to rise, supply will be increasingly scarce until 2017,” Cominotto added.
He argues the reason for this is that very few new development projects will be advancing with oil prices where they are right now with producers unable to generate sufficient yield until oil rises to about $70 per barrel and that total global demand is growing strongly.