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Market View

On the one side: A potential global oil glut. On the other: geopolitical tensions that could choke off key supply. We drill into the future to sort it all out.

 

In Brief

  • After U.S. president Donald Trump made a pledge on April 22, 2019 to drive Iran’s oil sales to zero, forcing trading partners to choose between Iran and the United States, crude oil prices surged.
  • But the bull was sidetracked on July 12, 2019, when an analysis of various forecasts showed major surpluses and not the supply shortfall that was expected to perpetuate the rally.
  • Barring any major disruptions of a geopolitical nature, lower crude oil prices will prevail heading into the new year, given current macroeconomic and production trends, according to Giulio Martini.  

 

Note: This is the first in Market View’s Sector Close-Up series, offering a periodic examination of conditions in key investment sectors and related investment insights.

After U.S. president Donald Trump made a pledge on April 22, 2019 to drive Iran’s oil sales to zero, forcing trading partners to choose between Iran and the United States, crude oil prices surged. With potential supply disruptions in the offing, many market participants were expecting oil prices to experience a bull rally this year and eventually through to 2020. Data from the International Energy Agency (IEA) show that the price of West Texas Intermediate (WTI) crude oil rose to $65.07 on April 22, 2019 from a low for the 12-month period (July 16, 2018-July 16, 2019) of $42.53 on December 24, 2018. (See Chart 1.)

But the bull was sidetracked by a countervailing development. In a report released on July 12, 2019, the IEA provided a preliminary analysis of various forecasts showing major surpluses and not the supply shortfall that was expected to perpetuate the rally. Rising U.S. shale production, a slowing global economy, and the prospects of an escalating trade war between the United States and major trading partners (mainly China), have all placed downward pressure on prices in recent weeks. WTI ended the period (July 16, 2019) at a price-per-barrel of $57.62, according to IEA.

 

Chart 1. Reflecting Geopolitical Turmoil, Crude Oil Prices Have Had a Bumpy Ride Year-to-Date
Per barrel price of West Texas Intermediate grade crude oil, for the 12-month period ended July 16, 2019

Source: International Energy Agency.  The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

The recent weakness in pricing comes despite such supply-constraining developments as pipeline infrastructure issues in Russia, the impact of U.S. sanctions on Iran and Venezuela (see Chart 2), and elevated tensions in the Middle East, all of which definitively cut oil output levels.

 

Chart 2. Sanction Shock: Oil Output Plunges in Iran and Venezuela
Combined crude oil production for Iran and Venezuela, (June 30, 2014-June 30, 2019)

Source: Bloomberg. The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

On the demand side, news that the International Monetary Fund cut its forecast for China’s economic growth in 2020 to 6%—the slowest pace since 1990—has also weighed on sentiment. Given that China has long been viewed as the engine of demand for commodity markets, this potentially does not augur well for the oil market.

While experts see crude-oil oversupply next year, they are not in agreement as to its severity. S&P Global Platts estimates the surplus in 2020 at approximately 400,000 barrels per day (bpd). The Energy Information Administration of the U.S. Department of Energy sees a 100,000 bpd surplus, while consultant Energy Aspects sees a stock-build of 500,000 bpd. Finally, and most alarmingly, IHS Markit is expecting a total surplus of 800,000 barrels/day next year.

But these bearish forecasts must be considered in the context of the unique vulnerabilities of the global oil market. Much of world supply comes from politically unstable regions, where sudden policy, infrastructure, or military developments can throw a wrench into the most carefully constructed projections. For example, news about a June 13 attack on two oil tankers in the Hormuz Strait—the world’s most important oil chokepoint which accommodates nearly 40% of seaborne trade—caused oil prices to jump 2.0%-4.5% intraday before paring losses, Bloomberg reported. A longer term concern: coming changes in fuel requirements for oil tankers could sideline a portion of the global fleet starting in 2020, according to a CNBC report.

Drilling Into the Future
Our international economist, Giulio Martini, Lord Abbett Partner and Director of Strategic Asset Allocation, believes that, barring any major disruptions of a geopolitical nature, lower crude oil prices will prevail heading into the new year, given current macroeconomic and production trends.

On the demand side, slower economic growth outside the U.S. and peaking (or declining) auto sales in the United States, China, and the euro zone will continue, he believes, to hold oil prices down.

On the supply side, production from low cost shale continues to grow rapidly – over 1.5 million barrels per day in the United States alone. Although lower prices have moderated drilling activity a bit, production cuts haven’t been nearly enough to adjust to weaker demand.

While falling prices is good news for consumers, at some point the downward trend will discourage capital spending, resulting in caps on production, which in turn, could, eventually, pressure prices higher.

But Martini believes that lower, not higher, prices are in the forecast for the foreseeable future.  “Investors should not underestimate the overhang of supply that exists in Iran, Libya, and Venezuela. Eventually,” Martini says, “while higher output in these countries is not imminent, when the supply from these big oil producers is back on the market, the price of crude oil is likely to decline sharply.  And we may never see $100 a barrel again (as we did in June 2014) unless a major shock, such as another oil embargo, causes a temporary price spike.”

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk. Credit risk is the risk that debt issuers will become unable to make timely interest payments, and at worst will fail to repay the principal amount. The principal risks associated with bank loans are credit quality, market liquidity, default risk and price volatility. While bank loans are secured by collateral and considered senior in the capital structure, the issuing companies are often rated below investment grade and may carry higher risk of default. Moreover, the specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustrative purposes only, and are not indicative of any particular investor situation.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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