Do OPEC cuts to oil benefit the US?
OPEC + production cuts show that energy security comes at a price. Analysis by Greg Sharenow, Portfolio Manager, Commodities and Real Assets, and John Devir, Portfolio Manager and Head of Americas Credit Research at PIMCO
OPEC + 's plan to reduce oil production complicates global economic, inflationary and geopolitical outlooks and is likely to lead to higher commodity prices. On October 5, the Organization of Petroleum Exporting Countries (OPEC) and its allies announced plans to reduce oil production quotas by 2 million barrels per day (b / d) starting in November. The actual production cut should be closer to 1 million b / d, as most member states are already producing below quotas.
We believe this move is supportive of energy prices as trade inventories are currently below average and would be at historic lows were it not for the release of global strategic oil reserves. This action could also exacerbate global inflation, complicating the efforts of central bankers. For investors looking to hedge inflation concerns or capitalize on a potential rebound in energy prices, commodity indices offer an attractive opportunity, especially given the historically high positive carry (forward prices are lower than spot rates) of the main commodity indices. Furthermore, the North American energy sector will be the main beneficiary of the OPEC + plan.
The reasons for OPEC + are manifold and the signal is clear
OPEC + argued the move was preemptive to avoid price weakness in the event that the Federal Reserve's tightening of policy to contain inflation leads to a slowdown in demand. Another reason given is that the world is underinvesting in the upstream oil and gas sector, so sustaining prices in the face of economic weakness will benefit everyone's long-term economic interests. With global upstream investment on a real basis around 25% lower than 2018-2019 levels, it is certainly worth supporting more investment.
While not explicitly stated, we would not be surprised if the decision was also made to rebuild reserve capacity in major OPEC states, which is close to record lows, to provide a buffer for future supply disruptions. Furthermore, it is difficult not to ask whether the proposal for a ceiling on the price of Russian oil by the Group of Seven (G-7) is a disturbing precedent for the other major oil producers, who have chosen to sympathize with Russia in the face. potential ire of global consumers.
Commodity investors have to gain
Although the oil market has rallied after the OPEC + announcement, this retracement is quite slight compared to the sell-off seen in recent months due to global growth concerns. Looking ahead, we believe the market could underestimate the potential decline in Russian production as EU sanctions tighten. Demand remains a problem with tightening financial conditions, but the particularity of last year is that energy and commodity markets in general have undergone some contraction without China acting as an engine of growth. If China were to aim to stimulate its economy to offset external headwinds, the impact on commodity markets would likely offset the negative demand implications of rising interest rates. With global oil stocks near the bottom of the historical range, leading to extremely high positive carry on the markets, we believe OPEC + equities support a positive return outlook.
The North American energy sector will benefit
A clear beneficiary of this context is the North American energy sector. Master limited partnerships (MLPs) and the midstream energy sector are the main beneficiaries, as the restriction of supply globally requires continued production growth in North America, and companies exposed to crude oil and liquefied natural gas ( GNL) are our favorite expressions. The OPEC + announcement is likely to provide US producers with greater confidence in increasing investment in the coming years, which is clearly good for midstream energy. We anticipate growth of around 5% in earnings before interest, taxes, depreciation and amortization (EBITDA) for MLPs and midstream energy over the next 3-5 years. Combined with the current yield of around 7.6% of the Alerian MLP index, we believe MLPs offer attractive double-digit total return potential and the opportunity to take advantage of a global energy tightening environment. While a demand shock would be negative for returns in the short term, energy sector balance sheets are better positioned to withstand an economic slowdown than in previous cycles.
The inflation risk for portfolios offsets our concerns about the economic slowdown
While we believe energy markets have significant value in generating returns and hedging inflation risk, in a scenario where rising interest rates lead to an economic downturn (i.e. a hawkish mistake by the Fed) we would expect equities and energy prices to struggle. That said, we believe the energy sector represents an attractive investment opportunity given the portfolio inflation risks seen overall over the past year. Furthermore, forward prices remain below levels that we believe may motivate the entry of additional and necessary capital.
As OPEC Secretary General Haitham Al Ghais said, "energy security has its price." In our view, the price is likely to be higher than the market currently suggests.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/energia/petrolio-tagli-opec-sicurezza/ on Sun, 23 Oct 2022 06:47:23 +0000.