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  • Natural Resources

    Oil Price Drop Not Surprising, Global Demand to Provide Support

    Shawn Reynolds ,Portfolio Manager
    March 10, 2017
     

    Contributors: Shawn Reynolds, Portfolio Manager, and Charles Cameron, Deputy Portfolio Manager for the Natural Resources Equity Strategy

    It has been a tough week for oil prices, with crude oil (West Texas Intermediate) dropping below $50 per barrel for the first time this year. As of the market close on March 9, prices are off 11% YTD after hitting a 12-month high of $56 on January 6. In our view, this selling looks overdone, but has created an interesting buying opportunity for our hard assets investment strategy.

    We are not surprised by this week's oil price decline given that markets often experience a period of meaningful profit taking after a strong year of performance as we had in 2016. Memories are short so it may be surprising to recall that oil was $29 per barrel back in January 2016.

    The Impetus Behind this Week's Selloff

    We do believe, however, that there are some unique technical/macro factors contributing to the recent selloff:

    • The market, in general, has been long crude oil in anticipation of a rebalancing in U.S. inventories. While we anticipate draws soon, many market participants have been exiting their long positions believing that these reductions should already have started.
    • Since mid-December (after the implications of the U.S. presidential election had started to be absorbed), crude oil has been trading in a relatively tight range and price volatility has been at historically low levels. We believe that the market has become overly comfortable with this tighter-than-average oil price range, and we are now reverting to oil's more normal trading pattern.
    • Given that Federal Reserve rate hike expectations have moved up to March, a significant amount of commodity positions have been cut in anticipation of slower growth on the back of higher rates.

    Looking ahead, we continue to believe that the "OPEC put" is quite strong (in the $40 range) and that the next commentary out of Saudi Arabia should reflect both increased pressure on current compliance and provide a clear indication that the quota system will be extended for three to six months further.

    Demand Remains Remarkably Resilient

    Despite recently strong U.S. drilling activity and production, most other macro and industry-wide fundamental indicators continue to suggest that supply imbalances remain ahead. We expect that a continuation of steady demand will easily offset today's short-term oversupply.

    Recent events in the market aside, our position for many years has consistently been that oil demand is remarkably resilient unless you have an unforeseen systemic risk event, such as a global recession. We expect neither in 2017. Long term, we see pro-growth policies, fiscal stimulus in the U.S., and support for growth in China as positive drivers. We expect global demand growth to continue at a fairly robust rate, and to provide support for oil prices.

    Rising Global Oil Demand
    1995 – 2018e

    Rising Global Oil Demand 1995 – 2018e

    Source: IEA; EIA. Data as of February 28, 2017. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue.