Summary

• The Oil Price strength continued (Brent +5.5% on the quarter)
• The OPEC did not raise production during their September interim meeting
• We are nearing the full return of Iranian sanctions in November
• Evidence builds that the US supply growth will moderate.

Market update

Oil prices rose 5.5% in Q3 2018, breaching the technically important level of US$80bbl during the last week of the quarter. The Managers of the Global Energy Fund have been expecting a 2018 closing price above US90bbl and are therefore maintaining a high oil price sensitivity. Consequently, the Fund outperformed its benchmark both over the month and over the quarter, finishing strongly in September. During the quarter, OPEC’s September meeting in Algiers passed with no further commitment to raise oil supplies. Despite a lot of threatening rhetoric from the US President, Trump was unable to provoke an increase in OPEC oil supply. OPEC’s power does not rest in the oil it produces, it lies in the oil it does not produce. The fact remains that, without spare capacity, OPEC is relatively impotent with regards to preventing rising prices. Trump’s removal of the world’s fifth largest oil producer, Iran (Iranian sanctions will be fully implemented in November) from the market, followed four years of collapsing international capital spend in the oil patch and their absence from the oil market was always going to be a tall order. In fact, Iran are likely to now focus on influencing oil prices in the only way left available to them – through disrupting supply from others and elevating the risk premium paid on the barrel, hence the military exercises performed over the Strait of Hormuz as OPEC sat in deliberation.

An early sign that Trump would not get his way could be seen in Saudi Arabia’s recent production and export data. July saw Saudi Arabia respond to an earlier Trump tweet calling for more oil from OPEC by promising to push oil production to 11Mbbld – however, talk is cheap and they promptly cut supply to 10.3Mbbld (the exercise of ramping up supply was never going to be that simple). Since Trump’s call for support from OPEC for more oil, the only country that has, since July, been able to increase production to any significant degree has been Libya, who increased production by 270kbbld v Saudi -140kbbld, and that source of supply increase could disappear in a heartbeat.

The Fund Managers expected the risk premium to remain elevated as inventories continue lower and spare capacity evaporates. Saudi spare capacity is at its lowest point, with regards to days of forward cover on record, in 10 years.

Activity

The Managers wanted to maintain a high oil price sensitivity (OPS), but paired down their exposure to oil service companies, preferring to garner our OPS from exploration and production (E&P) companies. This decision was derived partly from bottom up analysis and partly from an input we received from our technical analysis. The technical analysis encouraged us to reduce the oil services sub-sector and our bottom up analysis encouraged us to hold offshore services. Consequently, we switched our oil service holdings into E&Ps, the oil services that we did hold we held in offshore services.

During the period that we switched (late August) the oil services lagged in E&P, and offshore services outperformed onshore services, hence we added alpha in both adopting a more neutral stance in the sector and in our selection of onshore exposure.

Outlook

With considerable Iranian oil volume being removed from the market, the full sanction imposition hits the market at the beginning of November, combined with the inability for OPEC to make up the balance as well as indications that bottlenecks are restricting supply growth from the US, we continue to believe that oil prices will remain well supported in Q4 (breaching the US$90bbl price level). Consequently, we continue to remain bullish for the sector and the fund’s positioning.