Undersupply and low levels of stored oil may lead to a rise of prices of 15 per cent over the coming months, according to Ashburton Investments’ Richard Robinson.
As well as dwindling stocks, the market is also facing heightened risk to current supply due to the lack of spend and increasing political volatility in some oil-producing nations, such as Venezuela, Angola and Iran, said Robinson, who manages the Ashburton Global Energy fund.
The manager said the market was at a point of transition from abundant supply to shortages, due to the collapse in the approval of new oil projects since 2014.
As such, the manager believes oil prices could rise by 15 per cent by the end of the year.
“The seed is being sown for a structurally higher oil price, combined with heightened probability of risk premium,” said Robinson.
“Due to the collapse in capital spend, we believe the implications for the oil price are going to remain bullish for some time to come.”
In order to meet demand, Robinson said the oil market will increasingly rely on the growth in shale production in the US, which currently accounts for 8 per cent production of shale.
The oil market will also require an improving supply outlook from offshore production – which accounts for more than 30 per cent of total production.
However, the Ashburton manager noted that the process is long and could take from four to seven years.
Supply/demand balance for 2018
Source: OPEC Monthly Oil Market Report April 2018
“Compounding the challenge of undersupply, the International Energy Agency Demand’s (IEA) expectations are more often than not hopelessly undercooked,” he added.
“On average their demand expectations have been revised up by circa 700,000 bbld [barrels per day] since 2013.
“Thus, assuming 3.9 per cent global GDP growth and a relatively steady oil price, it wouldn’t be a surprise if oil demand increases 1.8-2Mbbld this year (versus the IEA start of year expectation of 1.3Mbbld), driven by growth in China and India,” Robinson said.
Indeed, in its 2018 outlook for the oil market, OPEC (the Organization for Petroleum Exporting Countries) highlighted robust demand from both countries, reflecting healthy manufacturing and road construction activities in the former, and rising demand in the transportation and industrial sectors in the latter.
Robinson said the combination of improved pricing and the volume of work needed to restore the supply balance is likely to benefit a raft of sub-sectors within the oil sector.
“In 2013, when Brent crude was over $110bbl [per barrel], the major oil companies were struggling to cover capex [capital expenditure] – let alone dividends – using organic cash flow,” he explained.
“Today, after cutting costs and making significant disposals, the oil majors have the ability to cover capex and pay dividends with Brent at $50bbl.”
As such, with the positive outlook for the oil price unfolding over the next few years, Robinson said integrated oil companies are beginning to show “significant cash balances”.
However, he noted industry reserve replacement ratios appear increasingly challenged post-2020, a problem that he believes should be addressed.
“We believe capex in the offshore space is poised to move higher – following the turn in onshore spend,” Robinson pointed out.
“The energy sector had a torrid time in 2017, despite a strong oil price. The weighting of energy stocks within the MSCI World index is close to an all-time low, despite a 77 per cent oil price rally from its lows.”
MSCI Sector weights
Source: FE Analytics
Indeed, energy stocks account for just 6.06 per cent of the MSCI World index, among the lowest sector weightings in the developed world benchmark.
Combined with the improved fundamentals, Robinson said this is a clear indicator the cycle is “due to turn”.
He said: “The last time we saw such a wide divergence between oil price performance and equity performance was 2002, the following year was the start of the five-year energy sector bull run, when energy stocks outperformed the S&P by 180 per cent.”
Robinson added: “In the upward period of the price cycle, we are looking to overweight subsectors displaying the highest oil price sensitivity – especially areas close to the source of the raw material, such as service companies and exploration and production companies.
“Given we believe the recent uptrend in the oil price will be sustained for the foreseeable future, we are currently overweight this area of the market – with our oil price sensitivity 30 per cent higher than the MSCI Energy benchmark.”
Robinson has managed the $44.7m Ashburton Global Energy fund since launch in 2013 and invests in a range of companies involved in oil, gas, coal, renewables and other energy sources.
In line with his views, the largest sector allocation in the fund is to oil & gas exploration stocks, which represent 28.87 per cent of the portfolio, according to its most recent factsheet.
It also has 12.87 per cent of the fund invested in oil & gas equipment and services stocks, and 8.89 per cent invested in drilling companies.
Its largest holding is US oil & gas giant Chevron Corporation, representing 5.09 per cent of the fund. Other top holdings include Canadian shale oil company Suncor Energy, Portuguese firm Galp Energiam and Middle East & North Africa-focused exploration firm DNO International.
Performance of fund vs sector and benchmark
Source: FE Analytics
Since launch, the offshore fund has delivered a return of 8.34 per cent compared with a loss of 5.12 for the average fund in the FO Commodity & Energy sector and a gain of 12.98 per cent for the MSCI World/Energy benchmark.
Ashburton Global Energy has an ongoing charges figure (OCF) of 1.41 per cent.