Summary

• The oil price rose almost 6% during the month, having suffered a pullback in the first two weeks.
• The benchmark started the month poorly, but rallied with the oil price and finished the month -4%.
• The Fund outperformed by 1%. A large majority of the outperformance emanated from the E&P and refining subsectors, with most of the alpha coming from selection.

Market

The IEA reported that crude inventories continued to slide moderately lower. This is their eighth fall in the last 11 months. OECD Inventories are now 32mbbls below their 5 year average. Overall the IEA OMR (Oil Market Report) demand outlook was bullish, despite the trade war and US dollar concerns. The IEA actually adjusted oil demand forecasts higher, by 210kbbld for the second half of 2018 and by 190kbbld over 2019. Non-OPEC supply was only adjusted moderately higher 27kbbld for both 2018 & 2019, consequently the amount OPEC need to produce, in order to balance the market increased, at a time when Iranian oil supply will be significantly reduced. July OPEC compliance with cuts was actually stable at 121%, versus June’s 121% compliance, despite the much vaunted initial 330kbbld increase from Saudi exports in June (exports actually slipped back 600kbbld in July). Saudi, unexpectedly reduced production by 110kbbld. Effective spare capacity continued to fall and now stands at 2.29mbbld (this includes Iranian spare capacity). We are also waiting for the IEA to start paring back US supply expectations. Having just returned from an oil conference in Scotland that was focused on US Supply, it is becoming more apparent that the rate of US production growth will plateau. Pipeline, human resource and the reluctance for US refineries to continue lightening their crude slate as a result of growing US, light oil and a loss of supply of heavier crudes will start to impact US production. Something that has been clearly communicated by a number of Service and E&P companies in recent meetings.

The total US crude and petroleum product inventories continued their slide lower (versus the 10 year average days of forward supply cover), hitting almost 11% below the average. Refiners are continuing to see healthy crack spreads, which is helping to drive demand.

Strategy

We moved our weighting of service companies to neutral, preferring to hold oil price beta through E&P (the technical model has registered an overweight in E&P). Our bottom up analysis suggests that our neutral weighting in energy service companies should be skewed towards offshore companies, due to the widening spread between ultralight US onshore versus heavier crudes found offshore. The E&P’s that we added to are focused on production outside of the Permian basin.