Image Source: Sollven Melindo
Commodity prices are notoriously volatile as the global markets often struggle to maintain a sustainable balance of supply-demand. Let’s take a look at some recent developments and coming events that are impacting the prices of crude oil and iron ore.
By Kris Rosemann
We’re not rushing to add any commodity-based exposure at the moment. We have some of course – but we’re not looking to add more to the newsletter portfolios.
For starters, the iron ore pricing market appears to be setting itself up for another period of pain, and we’re preaching serious levels of caution for those considering the space as iron-ore prices have already begun to descend from the peak of the puzzling early-2017 rally. Crude oil prices are showing signs of stabilizing after rallying considerably from the mid-$20s doldrums, but the sustainability of the recent supply-demand rebalancing is a major concern as we look to the back half of 2017 and beyond (especially as shale oil players ramp back up again).
We maintain our view that diversified exposure via the Energy Select SPDR ETF (XLE) and the Alerian MLP ETF (AMLP) are prudent ideas to consider as the potential commodity-price recovery ensues, while the position in Kinder Morgan (KMI) in the Best Ideas Newsletter portfolio offers a source of upside given the current sentiment surrounding energy and infrastructure in the US. We expect President Trump to be net-positive for the oil and gas sector during his tenure. Though we’ve held Rio Tinto (RIO) in the Best Ideas Newsletter portfolio in the past, we’re not interested in any iron-ore or steel (SLX) names for that matter.
Crude Oil – Will Production Cuts Be Extended?
OPEC’s announcement of a production cut in late 2016 was more than welcome news for oil producers, and non-OPEC countries including the likes of Russia jumping on board the effort to stabilize the price of the black liquid brought even greater optimism. But what good might the production cuts do if these producers return to pumping at previous levels once the six-month agreement is up (and what if US shale oil comes back in a big way)? Luckily for those entities’ fortunes tied to the price of crude oil (USO), reports are circling that OPEC is already working on an extension to its current production cut agreement. All eyes will be on the cartel’s May 25 meeting in Vienna.
We’re not ready to write these reports off as a victory for crude oil prices as we’ve seen our fair share of “posturing” from OPEC and other major players since the beginning of the fall in commodity prices beginning in late 2014, but news that there is strong support in the OPEC monitoring committee for a production-cut extension is most certainly positive (it can’t truly be negative). Furthermore, compliance rates have been much better than we initially expected, and OPEC’s reported 102% compliance with its production cut quotas in the month of April, up from 94% in February and 89% in March, supports sentiment that the cartel is open to extending the agreement. Saudi Arabia, often viewed as the “big dog” of OPEC, is said to be cutting more than its promised reduction and is reportedly open to discussion of an agreement extension.
Non-OPEC producers, however, haven’t exactly been cooperating in full. The IEA reported that non-OPEC countries that agreed to production cuts were only at 68% compliance in the month of March. Though this is a meaningful improvement from 38% in the month of February, it is still materially below the agreed-upon levels, and it may suggest that non-OPEC producers are not as open to extending production cuts as the cartel itself is. In any case, production data from non-OPEC producers is far more difficult to verify and may be unreliable.
What’s more is the increase in US production as independent exploration and production companies ramp up production. Production from the US has increased 400k barrels per day from September 2016 to March 2017, and the IEA expects US output to be up by 680k barrels per day at the end of 2017 on a year-over-year basis, while it expects global output to be up 485k barrels per day in 2017 compared to a decline of 790k barrels per day in 2016. The US rig count, as measured by Baker Hughes (BHI), supports such expectations, as the week ended April 28 marked the fifteenth consecutive week of an increase in the US rig count. The number of working rigs in the country has more-than-doubled from this time in 2016, and though it may face a long legal battle, President Trump’s recently signed executive order that significantly eases offshore drilling restrictions in the US supports the notion that US production growth is not going away.
Some US producers are preaching prudence, however, and the CERAWeek energy conference in mid-March offered some insight into how they are viewing the current market environment. Some stringent warnings came from the likes of Pioneer Natural Resources (PXD) CEO Scott Sheffield, who estimated oil prices could fall back to the $40 range if OPEC fails to extend its agreement, and Continental Resources (CLR) CEO Harold Hamm, who suggested that undisciplined growth from independent producers could “kill” the oil market.
One development caused by the recent collapse in energy resource pricing is the meaningfully improved cost structures of producers around the globe, which has resulted in substantially lower breakeven prices. Royal Dutch Shell (RDS.A, RDS.B) claims to have cut its well costs by 50% over the past two years, while other executives claimed to be able to avoid losses at prices as low as $12 per barrel on certain projects. Statoil ASA (STO) claims to have reduced its breakeven costs on new projects from over $70 per barrel to less than $30, and estimates have placed the decline in US shale plays’ well-head breakeven at 46%.
As a result, more projects are now economically feasible at far lower oil prices. For example, Total (TOT) CEO Patrick Pouyanne expects his company to approve up to 10 major projects over the next 18 months, while independent shale producers EOG Resources (EOG) and RSP Permian ( Categories Member Articles