Cycles and Strategies in Oil Investment – Part 1: Forecasting the Oil price
The investable universe of oil and gas stocks can appear large at first, but the field can be narrowed significantly through an understanding of the major drivers of performance. Stocks which make it through this initial screening can then be subjected to more in-depth analysis (Figure 1).
FIGURE 1: NARROWING THE UNIVERSE
The oil stocks which trade on the ASX show a strong correlation to the oil price, whether looking at TAPIS in AUD, WTI in USD, or Brent in either currency (see Table 1). As a result, identifying when a break from correlation should occur is critical when timing investment decisions and can contribute significantly to alpha.
TABLE 1: CORRELATION OF OIL PRICES TO ASX OIL AND GAS STOCKS
FORECASTING THE OIL PRICE
Forecasting the oil price requires an examination of demand and supply in the oil market. Other important drivers include the excess production capacity, global inventories, the marginal cost curve, refinery efficiency and utilisation, speculative investment flows, and political risk. Past up cycles have been driven by political risk and spare capacity, but only when GDP was growing and demand was strong (see Figure 2). The trigger on oil price to recover from down cycles has always been positive demand growth based on GDP growth (see Figure 3).
FIGURE 2: OIL PRICE AND KEY CATALYSTS
Equation 1: (%Δ GDP – 2%) = %Δ in global oil demand
FIGURE 3: GLOBAL DEMAND RELATIVE TO GDP
A review of supply/demand balance indicates that the call on OPEC crude will be ~-2.6 mmbbl/d in 2009 including Natural Gas Liquids (NGLs), and OPEC’s April output was ~ -2.9 mmbbl/d compared to 2008. Therefore stocks should begin to decline over the next quarters. This will provide fundamental support to the oil price which is unsupported now at current stock levels (see Figure 4), especially leading in to the US driving season which appears to be strong this year.
FIGURE 4: DAYS OF STOCK COVER VS. OIL PRICE
Days of OECD stock cover still stand at ~61 days, with OPEC indicating a target of 52 days (equivalent to $75 oil price in OPEC estimation). There is an excess 405 mmbbl (Million Barrels) of stock at present demand levels. At a -0.3 mmbbl/d supply deficit, it will take several years to reach this target without demand increasing. However, demand is expected to recover through the next quarters, and the amount of demand recovery will determine how fast the extra stock will be used.
Coming up next month
Cycles and Strategies in Oil Investment – Part 2: Leverage to the Oils Price
Krista Walter is Assistant Director, Investments Australia & New Zealand at Intellectual Ventures.
Previously, Krista worked at Macquarie Funds Management as an analyst. Krista utilised global oilfield management experience to facilitate fundamental analyses of companies and to make investment recommendations across all the Macquarie Funds groups based in Sydney, Australia.
