High oil price sensitive sectors performed well
The Fund garnered most of its outperformance from the high oil price sensitivity sectors of drilling, equipment, service and exploration and production companies (in that order). The Fund did not make any significant changes during the period.
Fundamentals continue to improve and geo-political risks elevate
Strong OPEC compliance (107%) and strong demand have meant that inventories continue to rebalance at a faster rate than the market anticipated only a few months ago. We are entering a period when, typically, OPEC exports begin to elevate, but note that floating storage in the Arabian Gulf and Saudi storage of crude are at multiyear lows, implying limited capacity to augment export figures from reduced production (however this factor is somewhat offset by a build in floating storage in the US Gulf coast as a consequence of the recent hurricanes affecting off loadings). Saudi appears to hold significantly lower inventories than the norm and continue to reaffirm their desire to limit export growth, particularly to the US (where most of the focus still lies).
Inventory in gasoline is now at a five year low and distillates are 6% below their five year averagelevels (ahead of a period that normally sees material inventory draws). Almost every key product is now in backwardation (futures curve is below spot, indicating tightness). Demand has also been surprising to the upside and IEA estimates continue to be readjusted higher (300kbbld stronger than anticipated at the beginning of the year), in fact, Q2 was the second strongest period of demand growth for crude oil since 2010. Consequently markets are a lot tighter than the recent price action was telling us they would be at this point in time. We also note that geopolitical risks have begun to elevate; Kurdistan vote for independence, Iranian nuclear agreement looks to be in jeopardy and Libya’s production volatility is back. The recent price recovery has, in our opinion, been fundamentally justified.
Equities have not kept pace with the oil price – we think this will change
Although the sector had a strong performance during September,the energy equities have not kept pace with the oil price recovery due to fears of oversupply in 2018, particularly driven by the fear of US production overshooting. However, it is becoming increasingly evident that the US onshore faces certain bottlenecks over the short/medium term – most notably in pressure pump availability and potential delays in localised sand production due to sand mining license applications hitting snags and issues regarding an ‘almost’ endangered sage brush lizard (for more information please see our quarterly) are proving to be a potential issue. If sand volumes are not increased we could see a delay in completions impacting supply of US crude.
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