Crude's rebound looks like just the start

Thought of the day

by Chief Investment Office 30 Nov 2018

The price of Brent crude rose 3.5% from an intraday low on 29 November, amid rising expectations that Russia is willing to cooperate with OPEC in curbing supply.

With Saudi Arabia and Russia both attending the G20 summit, this weekend may bring further developments, although investors will likely have to wait until the OPEC+ meetings next week for confirmation of any action by producers. But we believe that the recent rally will mark just the start of a more sustained recovery in prices for a number of reasons:

  • OPEC nations have a strong incentive to support decisive output curbs. The roughly 30% drop in crude prices since early October has pushed prices below the level most OPEC countries require to balance their fiscal budgets. For example, Saudi Arabia will be keen to minimize pressure on its budget, which slides into deficit if oil prices fall below USD 88 a barrel over a sustained period.
  • Added to this, memories are fresh of late 2014, when the cartel's refusal to cut production prompted oil to halve to USD 45 a barrel in just a few months. We expect OPEC+ to announce a production cut of at least 1mbpd at the upcoming 6–7 December meetings in Vienna, which should enable oil prices to stabilize and recover firmly in 2019.
  • Markets have been exaggerating the risk of a supply glut anyway. The recent slide in oil prices has been driven partly by a US decision to grant a waiver to certain nations, allowing them to continue to buy Iranian oil. However, the US is still insisting on a reduction in purchases from Iran, and lower Iranian exports will contribute to a tightening global supply in coming months.As a result, we expect Brent crude prices to rebound to a USD 70-80/bbl range in 2019, and we retain a preference for energy sector equities in the US and Europe. We advise investors with existing crude oil positions to keep their exposure. Risk-seeking investors can make use of the high option market volatility by selling the downside risk in crude prices.

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