Supply-pressures have been driven by both OEC and shale producers. Counter-intuitively, OEC’s production has been on an increasing trend despite the sharp fall in the oil price since 2014 and capacity is expanding as sanctions are lifted on Iranian exports. At the same time, crude oil inventories remain at record high levels; and yet shale production has plummeted since May 2015. Producers have been adjusting to the lower oil price, reducing the number of oil rigs and cutting capital expenditure, although the effects have not yet impacted the market.
The global supply surplus of oil is expected to continue until at least the later part of 2016, but it should reduce and reach a more balanced scenario. Market forecasts predict that oil will actually be in deficit by early to mid-2017. While OPEC is forecast to produce around the current levels, more importantly, we expect that the inventory should start to decline at some point next year, driven by the lagged effect of energy suppliers’ response this year.
Demand, meanwhile, should gradually improve, particularly as we see signs of stabilisation in China’s industrial sector. China’s structural slowdown is ongoing, but we remain of the view that global growth will improve modestly next year and global central bank policy will remain accommodative, although there will be some divergence between markets. Based on this scenario, we would expect the oil price to trade around current levels with volatility in the near term, before moving modestly higher as next year progresses.
Over the longer term, we believe that price dislocations in the commodities sector are opening valuation pockets across the market. We are maintaining an overall underweight position in the commodities sector based on our view that oversupply is likely to persist for now. However, other asset classes have been impacted by the commodities weakness and we are seeing the market becoming overly pessimistic about the fundamentals of individual names.
For example, the UK equity market is one of the most exposed to the commodities sector. At the height of the commodity super cycle, energy and mining stocks comprised more than 30 per cent of the UK stock market. Alongside the decline of commodity prices since 2014, this weighting has now almost halved.
London-listed commodity producers are starting to respond aggressively, however. Anglo American announced it would cut its dividend and Glencore has committed to slash net debt. Many of these stocks are trading at multi-year lows. Both Shell and BP have outlined capital expenditure cuts; indeed, their company managements have a demonstrable ability to manage effectively through challenging environments.
As balance sheets are consolidated across the industry and with improvements to the longer-term supply/demand dynamics particularly in oil, we have to surmise that this could be an area of value going into 2016. Another commodity super cycle is highly unlikely – China’s meteoric rise is one of those historical aberrations – but the commodities market should move into more equilibrium as producers adjust to supply-side structural shifts.
Michael Stanes is investment director at Heartwood Investment Management.
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