What OPEC might do at next week’s summit and why it matters to UK investors

Russ Mould
28 November 2018

“It is two years since OPEC cut production to support the oil price and the cartel now faces a tricky balancing act when it meets in Vienna on 6th December,” says Russ Mould, AJ Bell investment director. 

“On the one hand, its 15 members may want to at least stabilise prices, so they can pay their bills and fund welfare or reform programmes, while on the other President Trump is pressing for further falls in crude, even if the Brent benchmark has already dropped from $80 a barrel to barely $60.”

“To the surprise of many, OPEC stuck to its plan to cut output by 1.2 million barrels of oil a day to around 32.5 million, as non-OPEC producers chipped in with their own cut of 0.6 million barrels a day, half of which came from Russia.

“Those cuts were eventually extended to March 2018 and at times OPEC even cut more deeply, at times reaching a reduction of 1.8 million barrels a day.

“Coupled with respectable, if not rip-roaring economic growth and the threat of fresh American sanctions on Iran, those cuts were enough to help forge a recovery in the price of Brent crude, all the way up to nearly $80 a barrel. 

“But this autumn oil has rattled back to barely $60 a barrel, for a range of possible reasons:

•    America offered eight nations exemptions to its sanctions, so they could continue to buy Iranian oil

•    That American move may have caught oil traders on the hop. Throughout 2018, in anticipation of the imposition of fresh US sanctions, traders have been running huge ‘long’ positions of oil via the futures markets, in the belief that oil would continue to rise. At one point in April, speculative traders were net long of 769,743 contracts of 1,000 barrels each and at some stage they were going to want to sell, either to take profits or avoid losses. They have begun to liquidate this autumn, taking their net long exposure down by 44% to 429,854 contracts. Long positions have been cut and short positions – bets that the oil price will fall – have reached their highest level since November 2017 at 123,848 contracts. That wave of selling is likely to have weighed on the oil price.

•    US shale output has continued to mushroom, exceeding 7.7 million barrels a day in October, up nearly a fifth compared to a year ago. As a result, US stockpiles have also begun to grow once more, reaching 447 million barrels last week, up 13% from the 2018 low of 394 million in early September.

•    OPEC has itself started to increase production again. Led by renewed growth in Saudi Arabian output to some 10.6 million barrels a day in October, OPEC churned out 32.9 million barrels of oil a day.

“This all leaves OPEC with much to ponder, especially as its output of 32.9 million barrels per day covers barely one-third of global demand, so its power to influence prices may not be what it once was. OPEC, and Saudi Arabia in particular, may therefore look to Russia and non-OPEC producers for help and when there will be three things to look for in the communiqué that will be released once the Vienna meeting is over:

•    Any comments on production, relative to the 33.7 million-barrels-a-day level that prevailed before the cuts of two years ago, the 32.5 million target set then and the current rate of just under 33 million

•    Any comments on the time line for any production targets

•    And any pointers on the intentions of non-OPEC members, particularly Russia, which reduced its output by some 300,000 barrels a day, or around half of the total non-OPEC cut

Why OPEC and oil prices matter to UK investors

“Although attempts to manage the oil price may seem futile to some and irrelevant to others, crude could influence the value of investors’ portfolios, at least in the short term, in three ways.

Inflation
“An oil price shock caused all sorts of inflationary trouble in the 1970s and the disinflation of the 1980 and 1990s, as oil cooled and slid all the way to $10, was a big contributor to the stock market boom which characterised those two decades. A relatively stable oil price, or at least one that is not galloping higher, could at least take a little pressure of the inflation figures and give the Bank of England more room for manoeuvre when it comes to interest rates and monetary policy. And since higher interest rates ultimately stop stocks in their tracks, rather like weight stops trains or racehorses, a low-inflation, low-interest rate is probably preferable for equity investors, at least relative to one where inflation and borrowing costs are heading sharply higher.

Oil companies’ earnings and dividends
“The oil and gas sector is hugely influential in the UK equity market. BP and Shell represent one-sixth of the FTSE 100’s market capitalisation between them and they are forecast to generate roughly a fifth of the index’s total profits and dividend payments in 2018 and 2019.

“Oil’s surge from $30 to $80 a barrel has allayed fears that either of the oil majors would need to cut its dividend and BP has actually started to increase its shareholder distribution once more. The drop back to $60 a barrel should not jeopardise those payments so investors may perhaps welcome some careful price management from OPEC which means that oil neither goes too low (so as to again put pressure on BP and Shell’s cash flows) or too high (so as to perhaps force the Bank of England’s hand on interest rates).

 

 

 

 

 

 

 

Market cap

 

Earnings

 

Dividends

Financials

20%

Financials

23%

Financials

21%

Oil & Gas

16%

Oil & Gas

18%

Oil & Gas

20%

Consumer Staples

15%

Mining

16%

Consumer Staples

13%

Consumer Discretionary

12%

Consumer Staples

13%

Mining

11%

Healthcare

11%

Consumer Discretionary

10%

Consumer Discretionary

8%

Industrials

10%

Industrials

8%

Healthcare

8%

Mining

9%

Healthcare

7%

Industrials

7%

Telecoms

3%

Telecoms

3%

Telecoms

6%

Utilities

3%

Utilities

2%

Utilities

4%

Real Estate

1%

Technology

0%

Real Estate

1%

Technology

1%

Real Estate

0%

Technology

1%

Source: Digital Look, consensus analysts’ forecasts

“Brent crude oil is now marginally lower than it was a year ago and there are also some sectors which may welcome lower oil, notably General Retailers and Travel & Leisure, as lower prices at the pumps and lower fuel bills leave more cash in consumers’ pockets.

“Industrial Transportation should in theory welcome lower fuel bills, too, although the sector sailed through year-on-year oil prices of more than 50% in 2016, just as they did in 1987, 1989, 1997, 2005 and 2010. That said, sentiment toward airline stocks tends to perk up as oil goes down, even if the carriers’ hedging policies mean that they often do not glean any immediate benefit to their cost base.

“Despite the importance of oil to FTSE 100 earnings, investors will be aware that 80-85% of the index’s market cap, profits and dividends come from other sectors. Higher fuel and energy bills represent increased costs for companies and consumers alike, although data since the launch of the FTSE All-Share in 1984 and the FTSE All-World benchmarks in 1994 would suggest that it needs a sustained increase of 100% year-on-year to signal real trouble ahead – and oil is now down year-on-year, so this may be one less thing for stocks to worry about, even if increased wages and borrowing costs are potential sources of margin pressure.”
 

Follow us: