OPEC Unleashes the Oil Bull

OPEC Unleashes the Oil Bull

The honours went to oil overnight. West Texas Intermediate and Brent crude soared more than 8% on the back of an unlikely OPEC agreement to cut supply starting from January.

The response was magnified by the fact that the market was highly sceptical of a positive outcome, and oil sold off leading into the OPEC meeting.

The Financial Times has the details:

Opec has agreed to cut supplies for the first time since the global financial crisis eight years ago, sending prices soaring above $50 a barrel as Saudi Arabia and its Gulf allies accepted big reductions in production.

The cartel, which pumps a third of the world’s oil, reached the deal to cut 1.2m barrels a day to about 32.5m b/d for six months from the start of January after six hours of talks in Vienna. There is an option to extend the agreement until the end of 2017.

Apparently, Russia, a non-OPEC member, also agreed to cut production.

What’s with the cooperation?

I’m no energy analyst, but, to state the obvious, it seems clear that the oil bear market that raged from 2014 through to 2016 was devastating for the major oil exporters.

Saudi Arabia’s decision a few years back to pump up supply and decimate US shale oil producers appears to have backfired. All it did was lower costs across the industry, as shale oil producers fought to stay in business.

This meant that many (if not all) Persian Gulf producers saw revenues plummet and budget deficits rise. Saudi Arabia, for decades a nation that invested its surplus oil revenues in US Treasuries, has to issue its own bonds for the first time this year.

The agreement therefore represents an acknowledgement that sub-US$50 a barrel oil prices are not in the interests of any major producer. Kept there for too long, it risked financial stress, which would lead to social upheaval and potential regime change.

That’s why the price jumped so sharply. OPEC sent a message that they cannot, and will not, tolerate ultra-low oil prices.

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The question is: How much can they really influence prices beyond a few days?

My guess is not a huge amount. The statement simply came at a time when oil prices were trending higher anyway. If oil prices were in a downtrend, this supposedly bullish statement would not have had much of an impact.

To explain what I mean, check out the chart below. It shows the spot price of West Texas Intermediate crude oil. As you can see, it bottomed in January and February of this year, and has since been working its way higher.


Source: StockCharts
[Click to enlarge]

The blue and red lines are the 50-day and 100-day moving averages. When the blue is above the red line, it’s a rough proxy for a stock or an asset being in an upward trend.

On this score, oil went into an upward trend in April, and has stayed that way ever since. Despite the volatility and bearish opinions that oil would fall back to its lows of earlier this year, the fact was that the trend was moving higher.

A good rule of thumb to use is that the probability is higher that the trend will continue, rather than reverse. Of course, trends do reverse. But when you put a little analysis around it, you can fine-tune your thinking and increase your chances of success.

For example, rising oil prices over the course of 2016 told you that the outlook for global economic growth was improving. When Trump won the election, and bond yields started heading higher, this was another sign that growth prospects were improving.

Against this backdrop, the odds were in favour of oil continuing to trend higher, OPEC meeting or not.

I’m not just engaging in hindsight analysis here. I’ve been building the Crisis & Opportunity portfolio up with energy exposure over the past few months. The decision to do so was on the basis that oil had bottomed and would move higher from here.

It was also due to some digging I did into the Aussie energy market. There’s a little-known part of the Aussie East Coast gas market that stands to benefit enormously from rising energy prices. These are the companies that will benefit from the East Coast LNG revolution that the Aussie market has undergone over the past few years.

I’m not talking about the big players like Santos [ASX:STO] or Origin Energy [ASX:ORG], who were involved in building some of the huge LNG plants in Gladstone, Queensland.

I’m talking about smaller players that will ride on the coattails of these guys.

The establishment of a huge LNG export industry means Australia has to find more gas to send to the export terminals in Gladstone. It’s squeezing domestic supply as we speak. And I’ve identified three small companies that are in the box seat to benefit from it.

The share prices of all three are up strongly today. But I think this is just the start. To find out more about these companies, and what they’re doing to take advantage of higher energy prices and the coming East Coast gas squeeze, click here.

However, there were casualties from the oil price surge overnight. US 10-year bond yields jumped nine basis points, to 2.38%, while gold fell to US$1,173 an ounce. Right now, gold and US bond yields seem to be moving in tandem.

If the correlation continues, gold has further to fall. A 10-year bond yield of 2.38% is still too low if the US economy continues to pick up.

Just yesterday, US economic growth was revised up for the third quarter, to an annualised rate of 3.2%. Add in inflation, and bond yields should arguably trade in the high 3% range.

While it remains to be seen just how robust the US economy is, the overnight reaction from the oil market tells you that the global growth outlook isn’t as dire as many believe.

Regards,

Greg Canavan,
For Markets and Money

Editor’s Note: Newman Show Hijacked! James Woodburn and Kris Sayce hijacked The Newman Show to discuss recent market news across Money Morning and Markets and Money.

Join Woody and Sayce for an informal discussion on…Trump infrastructure spending…where the money’s going…resource investment opportunities…how far the Aussie housing market has left to run…the war on cash… You can watch all that, and more, right here.

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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