Market Bulletin November 17, 2014

Transcription

1 Market Bulletin November 17, 214 What is behind the recent slump in oil prices? Anastasia V. Amoroso, CFA Vice President Global Market Strategist J.P. Morgan Funds Ainsley seye. Woolridge Market Analyst J.P. Morgan Funds What caused oil prices to tumble almost 3% since late June? Brent crude prices tumbled from $113 per barrel in late June to $8 per barrel as of close on November 14, while U.S. West Texas Intermediate (WTI) crude declined from $13 per barrel to $75 per barrel in the same timeframe. EXHIBIT 1: OIL PRICES REGISTER STEEP DECLINES WTI and Brent crude prices Brent Crude WTI Crude Oct '13 Jan '14 Apr '14 Jul '14 Oct '14 Source: FactSet, J.P. Morgan Asset Management. For illustrative purposes only. What caused this? Put simply, the price decline was caused by a mismatch between the global demand for oil and the global supply of it. In September, the Energy Information Administration (EIA) released its monthly Short-Term Energy Outlook in which it cited weak demand from OECD economies. Indeed, EIA expected a decline of 21, barrels per day in OECD consumption in 214, with the decline led by Europe and Japan. In its latest monthly report, the agency revised OECD consumption lower again to a decline of 3, barrels per day in 214.

2 EXHIBIT 2: SLOWING DEMAND FROM EUROPE AND JAPAN World liquid fuels consumption growth, millions of bbl/day.8 Forecast OECD* Non-OECD Asia Former Soviet Union Other Source: EIA, J.P. Morgan Asset Management. For illustrative purposes only. Recent OPEC Monthly Oil Market Reports noted a similar trend highlighting the economic slowdown in Europe and Japan, which is also evident from the recent soft patch in manufacturing surveys. Amidst the slowing growth in global demand, growth in the global supply of oil accelerated. Production in Libya popped from 3, barrels per day in June of this year to 85, barrels per day in October. Meanwhile, production from Saudi Arabia, OPEC s largest producer, was largely unchanged. EXHIBIT 3: ACCELERATING OIL SUPPLY FROM THE U.S. AND LIBYA Crude oil production, millions of bbl/day Libya (RHS) Saudi Arabia (LHS) United States (LHS) 4 '9 '1 '11 '12 '13 '14 Source: Bloomberg, J.P. Morgan Asset Management. For illustrative purposes only According to Bloomberg estimates, Libya s increased oil production caused total OPEC production to move above its quota of 3 million barrels per day, where it has remained for several months. Production from outside of the OPEC countries has also risen, contributing more oil to an already saturated energy market. The U.S. is primarily responsible for most of the non-opec growth in production, and within the U.S., it is tight oil (sometimes also referred to as shale oil) that is driving that growth. As estimated by the EIA, non-opec supply growth in 214 of +1.9 million barrels per day exceeded the estimated demand growth of +.9 million barrels per day, an imbalance that, compounded by above the quota OPEC production, resulted in a sharp decline in oil prices. Something s got to give The key factor to remember about imbalances is that they do not last forever. In 212, oil prices declined by a similar 3% from March to June, but quickly reversed in the subsequent three months. Prospects of sanctions against Iran and fears of a potential blockade of the Strait of Hormuz depressed supply expectations in the first quarter, at the time when hopes of a European recovery lifted demand projections, causing oil prices to rise early in the year. Then, in the second quarter of 212, European growth projections came crashing down as the sovereign debt crisis flared up again. Meanwhile, Libya contributed to a boost in production above the OPEC quota while Saudi Arabia did not cut its production. That, coupled with strong U.S. production and falling growth expectations in Europe, contributed to an imbalance of supply and demand for oil, leading to lower energy prices. Sound familiar? The third quarter of 212 saw a reversal of this imbalance. Mario Draghi delivered his now famous whatever it takes speech to the markets, which re-ignited European growth expectations. Also during the third quarter, oil production from Iran declined and overall OPEC production fell to levels seen during the first quarter. Thus, higher growth expectations and lower actual supply led to a rebound in oil prices in 212. There are several factors that might correct the current imbalance. Let s start with demand that may still turn up, and production that may slow down. Indeed, EIA forecasts world demand to grow by +1.1 million barrels per day in 215, as consumption from Europe and Japan improves, while non- OPEC supply is projected to change by +.9 million barrels per day, below the growth rate seen in

3 EXHIBIT 4: LAST 3% DECLINE IN OIL PRICES WAS IN 212, FOR REASONS NOT TOO DISSIMILAR OPEC production, thousands bbl/day, Brent crude, $/bbl 32,5 32, 31,5 31, OPEC Production (LHS) 125 EXHIBIT 5: DIFFERENCE BETWEEN ACTUAL OIL PRICE AND ESTIMATED BREAKEVEN PRICE OPEC country s main export crude price minus its 214 fiscal breakeven price, $/bbl ,5 1 3, 29,5 OPEC Quota Brent tcrude (RHS) , -4 28, Kuwait Qatar UAE S. Arabia Iraq Iran Source: Bloomberg, J.P. Morgan Asset Management. For illustrative purposes p only. Also, OPEC may be mulling over production cuts at an upcoming meeting of oil ministers on November 27, in Vienna. The stated OPEC mission is to secure efficient, regular and economic supply of petroleum to consumers, and a steady income to producers. At an OPEC basket price of $73.47 per barrel, more and more OPEC producers are starting to see crude oil prices that are below the fiscal breakeven points required to achieve a balanced budget. Since OPEC governments rely heavily on oil revenues to finance spending, that is a crucial point. For example, Iran s Iran Heavy crude price of $84.61 per barrel at the end of October is well below its estimated fiscal breakeven of $131 per barrel, and Iraq s Basrah Light price of $83.57 per barrel at the end of October is also significantly below its breakeven price of $19 per barrel. It is understandable, given these dynamics, why some OPEC producers are starting to feel the pain of lower oil prices. Even Saudi Arabia s Arab Light grade at $85.93 per barrel at the end of October was slightly below its fiscal breakeven. Source: IMF, OPEC, J.P. Morgan Asset Management. Crude oil prices are as of 1/31/14. For illustrative purposes only. While Saudi Arabia, given its reserves and current budget surplus, may be able to withstand low crude oil prices for longer, the less financially secure producers within OPEC may start exerting pressure to cut the production quota. After all, the price of oil has been declining for months, not weeks. An OPEC production cut in November or early next year may help correct the current oversupply. Also, the growth in U.S. shale oil may slow at the margin next year, as companies may trim their drilling plans amidst lower oil prices. Moreover, the staggering growth rate in shale oil production seen since 211 is projected to slow in the coming years and fall in the longer term, as currently known and economic areas become depleted. Of course these assumptions are subject to considerable uncertainty about future finds and technological advances. Lastly, the annual fall maintenance season for U.S. and global refiners meant that crude oil demand slump is also due to the seasonal factors. Looking ahead, the projected refinery outages decline measurably as we approach the winter months. 3

4 EXHIBIT 6: U.S. TIGHT OIL PRODUCTION GROWTH RATE FORECAST TO SLOW EIA tight oil production forecasts, thousands of bbl/day 6, 5, 4, 3, 2, 1, But on the other hand, a $75 barrel of oil means cash out of the pockets of energy producers. Indeed, the falling price of oil wreaked havoc on select parts of the equity and fixed income markets. Compared to the year-to-date total return of +12.4% for the S&P 5 index, the energy sub-index decreased -1.2% in 214 and energy small caps fared far worse with a decline of -2.2% for the year. Similarly, high yield debt of energy companies, which constitute 18% of the JPMorgan Domestic High Yield benchmark, lagged the benchmark with a total return of +1.3% for the energy subindex versus +4.4% for the index. EXHIBIT 8: ENERGY STOCKS UNDERPERFORMING Returns, indexed to 1 12 '11 '15 '19 '23 '27 '31 '35 '39 11 S&P 5 Source: EIA, J.P. Morgan Asset Management. For illustrative purposes only. EXHIBIT 7: GLOBAL REFINERY DOWNTIME IS SET TO DECLINE Crude oil consumption lost due to downtime, thousands of bbl/day S&P 5 Energy Sub-Index 8 Russell 2 Energy Sub-Index 6 4 Actual 7 Dec'13 Feb'14 Apr'14 Jun'14 Aug'14 Oct'14 Source: Standard & Poor s, Russell Investment Group, FactSet, J.P. Morgan Asset Management. For illustrative purposes only. 2 Projected Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Bloomberg, J.P. Morgan Asset Management. For illustrative purposes only. Investment implications The broad equity markets have remained resilient in the face of lower energy prices because it is widely understood that the falling price of oil has more to do with the supply side of the equation than demand. Lower oil prices, on the one hand, provide an economic benefit as lower gas prices at the pump translate to cash in the pockets of consumers, just in time for the holiday shopping season. EXHIBIT 9: ENERGY HIGH YIELD IS TRAILING THE BENCHMARK Returns, indexed to U.S. Energy High Yield U.S. High Yield 99 Dec'13 Feb'14 Apr'14 Jun'14 Aug'14 Oct'14 Source: J.P. Morgan Asset Management. For illustrative purposes only. Data are as of 11/17/14. 4

5 A turnaround in the price of crude oil is crucial to a turnaround in the energy sector within equities and fixed income. Falling oil prices hurt profit expectations and raise fears of potential defaults, for some companies more than others. However, there are some mitigating g factors. The breakevens in the Permian, Eagle Ford and Bakken areas, which account for 9% of tight oil production, are in the range of $6-$7 per barrel (Wood Mackenzie). Plus, many oil and gas producers do not leave the price of these commodities to chance, and hedge a significant portion of their future production volumes, partially in order to meet their debt service obligations. EXHIBIT 1: OIL HEDGING FOR SELECT HIGH YIELD ISSUERS 215 estimates assuming no growth in 214 average daily production Company Est % of 215 Oil Volumes Hedged W. Ave. Price ($/bbl) EP Energy 15% $91 HalcÓn Resources 8% $87 Concho Resources 63% $88 Linn Energy 59% $94 Chesapeake Energy 55% $93 Source: U.S. SEC, J.P. Morgan Asset Management. For illustrative purposes only. If lower oil prices persist, future investment and earnings growth for energy companies will slow. However, if oil prices turn around, given the recent underperformance and retrenchments of P/E ratios from 14.7x on a forward basis in June to 14.x as of November 14, the sector offers value. Imbalances, after all, do not last forever. Any performance quoted is past performance and is not a guarantee of future results. Diversification does not guarantee investment returns and does not eliminate risk of loss. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Reference to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but are not limited to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc. JPMorgan Distribution Services, Inc., member FINRA/SIPC MI-MB-Oil_Nov214 JPMorgan Chase & Co., November 214 5