A panel of experts at a recent forum in Los Angeles, California have said that the dramatic decline in oil prices over the next six months is unlikely to reverse itself for the foreseeable future, and indicates that OPEC has lost control of the market. The consensus of the entire forum was that the decline in oil prices represents a tsunami, a long term shift that could hold per barrel prices in the US$50 – 60 region for the next several years.
Research Analyst J. Gibson Cooper said, “last October, with US oil production surging, the Saudis and other countries such as Oman, Kuwait and the UAE started discounting the price of oil to Asia in an effort to keep share. At the OPEC meeting a month later, there was an expectation that the cartel would use its natural control of the market to adjust the perceived supply/demand imbalance, but nothing was done, a signal that OPEC had lost control and that the cartel effect was over.” This has created a dramatically altered landscape that has forced financial advisors to rethink fundamental investment strategies.
Good news was spoken of by Ryan Brist, Head of US Investment and said that from a portfolio perspective, “you’ve got a lot of time here” a sentiment that Cooper echoed. “Our expectation is you will see defaults rise moderately in the energy sector. We don't think 2015 is a year of massive pain for high yield energy credits generally. Given our view that oil will probably stay around this price for a couple of years, 2016 is a bigger question.” Cooper did continue however that for now, the energy remarket remains appealing. “Yes, defaults will rise, but we think current spread levels and prices over compensate for default risk.”
It was indicated by Brist that there may be downside risk in the high grade marketplace, but that other opportunities are widely available. “There’s a great dispersion in energy and, especially in emerging markets like Russia and Brazil, where we’re talking about fraud and government intervention, I’d be cautious. But high yield looks pretty interesting; from a portfolio perspective, that would be my focus.”
Cooper looked more deeply at high yield, which he said is an extremely large market. “Broadly speaking, it’s three major sectors: exploration and production, oil service companies and then the midstream sector. That midstream space is still a large part of our strategy. Nearly all of those are structured as master limited partnership (MLPs), and we think that subset of energy will do just fine under any commodity environment.”
Right now, the analysts on the panel affirmed, the name of the game is liquidity. Cooper commented, “the question is whether you can build levers or bridges in your business to withstand a low commodity environment. Our assumption is that not everything works at US$50 – 60 in the US, or even globally.”
Also, upside risks always exist, particularly with a cartel that controls 30 million bpd of production, Cooper pointed out. “We’ve seen issues in Iraq, Libya has been a concern and there’s a big election in Nigeria that keeps getting postponed, it’s very violent and we’ve seen production in fits and starts there. However this past quarter, Cooper noted, everything ha gone right for production: the US has been doing well, OPEC production has been strong and volatility has stayed low.
As Brist see it, all of this reduces the chances of a dramatic surprise in oil prices. He said, “analysts are very good at counting barrels on the supply side, but demand is a hard thing to gauge,” and based on current conditions he said, “I think the base case, that US$50 – 50/bbl price, is our highest probability.”
Edited from press release by Claira Lloyd
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