Will Oil Be The Next Rally?

This article was originally published at MF & Co. Asset Management.

Over the past few weeks there has been a lot of speculation around where the price of oil will go, will oil be the next rally?

The oversupply to the market pushed down the oil price from $80 US per barrel down to below $50 US dollars per barrel. With the recent commitment by OPEC to cut production by 1.2 million barrels per day, asks the question of when will the oil price return to previous levels.

A production cut doesn’t necessarily mean the oil price will sky-rocket, it will take some time for the price to recover to previous levels. The slow recovery to previous levels will be worth the wait.

As seen below, oil has been coming off throughout the past couple of months:

Oil (ASX OOO) - Will oil be the next rally - Bloomberg Brent WTI

Where is the oil price going?

The recent production cut agreed to by OPEC of 1.2 million barrels per day will certainly affect the price of oil, but as there is no date for the production cut to come into effect has made for the potential volatility to both the downside and upside certain. The volatility was voiced on the 18th December as “planned production curbs by global producers, led by Saudi Arabia and Russia, failed to allay concerns about oversupply stoked by swelling US shale output; saw Brent crude tumbling 5.6%, and WTI down 7.3%”.

There are still some factors hindering the rise in the price of oil. Fear of weaker demand for oil has oversupplied the market due to the potential global slowdown in the global economy, supported by recession fears. The US-China Trade War also poses a risk, if they don’t reach an agreement will deter economic growth and thus decrease the demand for oil.

President Trump doesn’t help with numerous statements of his joy for a low oil price, and now with US production being the largest in the world means there won’t be any commitment from the US to limit oil production. Saudi Arabia also just had their largest on record output of oil, oversupplying the market.

Factors counteracting low oil price

The commitment by OPEC to cut oil production by 1.2 million barrels per day weighs heavy, supported by sharp declines in output by Iran because of sanction waivers from the United States. Venezuela has also slid in their output due to the turmoil in their country. Libya’s largest oil field, El Sharara, has been halted due to security concerns.

US shale oil has a large contribution to oversupplying the market, but there is one key fact that hurts the output from the United States. Majority of shale producers are only in profit after $50 US WTI per barrel, after this they will run into loses. If the oil price stays at these low levels will naturally correct the effect, causing production cuts by shale producers till oil prices recover; otherwise, they will incur too many loses.

Demand tends to pick up from January onwards due to the Northern Hemisphere demanding more oil coming out of winter.

Oil (ASX OOO) - Will oil be the next rally - 2017 WTI Crude Oil Futures Seasonality

When will oil fight back?

In theory, it will take a couple of months after a production cut for the price of oil to react to demand pressures.

Supported by the seasonal demand pressures from January onwards will hopefully see a gradual increase in oil price over six months, this is on the basis that supply has dropped and economic growth continues. If China & the United States don’t reach a trade deal will place downward pressure on the oil price as global economic growth will be expected to fall.

How to gain exposure to oil?

The ETF-OOO provides investment results that correspond to the price and yield performance of the S&P GSCI Crude Oil Index, with a currency hedge against movements in the AUD/USD.

As you would expect OOO over the past few months has dropped from $21 to $13.

There is a strong probability the oil price would stabilise and gain over the next few months due to production cuts from Canada, OPEC and Russia set to come into effect after January. If the United States & China reach a trade deal will boost the expected outlook for global economic growth, placing more global demand for oil.

Buying the ETF-OOO is a good opportunity for a short-term, high-risk trade, with potentially great upside.

This article was researched and co-produced by Jean-Marie Klumper, an Adviser at MF & Co. Asset Management.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.

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