On 8 May, President Trump announced his decision to “cease the United Sates participation in the joint Comprehensive Plan of Action (JCPOA) and to begin re-imposing the US nuclear related sanctions”. The process of implementation will be staggered across a 90 and a 180 day wind down period. By 4 November, the US will re-impose sanctions on petroleum related transactions with the National Oil Company of Iran (see Trump withdraws from Iran nuclear deal ). We anticipate European commercial participation and a degree of Asian nation participation (South Korean imports of Iranian crude have already dropped by 25-30%). Consequently, the market was dealt a boost to its fundamental bullish case. Sentiment sent the oil price higher (Brent hit US$80bbl). However, with imminent mid-term elections, Trump was in no mood to acknowledge his part in sending oil prices higher and promptly blamed OPEC for undersupplying markets.
The Saudis and the Russians kowtowed to the Trump edict and announced they may return a portion of the production cuts to the markets. There are now strong arguments in favour of a return to full supply. Inventories are now low and we anticipate significant undersupply stretching over a number of years. However, a supply increase is certainly not a given. Any OPEC+ country currently suffering from high decline rates in their oil fields as a result of under investment and consequently involuntarily unable to meet their current supply quotas have absolutely no incentive to support a hike in OPEC+ supply. Those OPEC and OPEC+ countries that are involuntarily undersupplying include: Venezuela, Angola, Algeria, Ecuador, Equatorial Guinea, Mexico, Azerbaijan, Brunei and Sudan. Although Saudi Arabia could very easily act alone, its willingness to do so will be tempered by its desire to retain cohesion between the group. If we get a repeat of the 2011 OPEC debacle, when the meeting broke up in disarray following Saudi Oil Minister Al-Naimi’s failure to garner support for his proposed 1.5mbbld supply hike (as compensation for Libya’s decline), it will not auger well for future OPEC co-operation. OPEC regained its credibility with its recent cooperation and it will be keen to obtain a similar level of co-operation with regards its exit. However, it is hard to see how those countries that have lost control of their decline rates will co-operate before they see a return of their own domestic spare capacity and the ability to participate in a supply hike (something that could take a number of years). Certainly a moderated, staggered return (circa 300kbbld as proposed by Saudi Arabia) could be more palatable than a more significant return (800kbbld, as proposed by Russia).
With regards to US production in May, we witnessed further evidence that bottlenecks are really biting and a continuation of the cadence in much needed US onshore supply growth looks increasingly doubtful. The price of Midland crude fell 11% in May (whilst Brent crude moved 3% higher). Consequently Midland crude is now down 9%, year to date and is trading at a discount to Brent of over US$20bbl. The Fund is no longer invested in un-hedged Permian producers, preferring to shift its focus onto Exploration and Production (E&P) companies exposed to offshore fields and onshore basins either in the Bakken or Eagleford. The Fund has also invested in a number of refiners set to benefit from buying cheaper input crudes as a result of the bottlenecking and the widening spreads. The refining sector was the Fund’s largest contributor to alpha in May (due to selection), followed by Service companies (due to selection), Shipping (allocation), Drillers (selection) and then E&P (selection).
We remain bullish with regards to fundamentals and believe that the long term outlook for the sector is extremely attractive.
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