Crude Oil, The One To Watch

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | May 23 2018

In this week's Weekly Insights:

-Crude Oil, The One To Watch
-FIIG High Yield Conference: Get Ready
-Housing Finance Growth, The Australian Canary?
-CSL, Sign O' The Times
-Rudi Talks
-Rudi On TV
-Rudi On Tour

-At The AIA Conference

[Note the non-highlighted items appear in part two on the website on Thursday]

Crude Oil, The One To Watch

By Rudi Filapek-Vandyck, Editor FNArena

There are probably as many similarities with the situation in 2008 as there are differences back then with global energy markets today, but one key characteristic hasn't changed: energy producers are one of the best performing sectors on the stock exchange and many an enthusiastic market follower is looking upwards for more investment gain potential.

Can we really see Brent crude oil futures revisit US$100/bbl this year?

If so, the answer may not lay with Saudi Arabia and OPEC, but more likely with Venezuela, or Iran (Trump permitting), while the US shale industry sorts out its infrastructure bottlenecks. Equally important, if we do get to see further upside in global oil prices, at what point does this start to weigh upon market sentiment?

One historic correlation the world temporarily forgot about back in 2008 (despite me reminding everyone who cared to listen), is that higher priced oil does come with consequences for everyone outside the oil industry. Even mining companies experience a spike in their bills for diesel to keep those big Tonka trucks on the road and moving dirt.

One popular saying is that higher priced oil is effectively a higher tax on the broader economy with both households and businesses forced to pay up. No wonder thus, a significant rise in the price of energy is what has caused economic recessions in the past, including in 2008 (even though that correlation is seldom highlighted).

Usually, the rule of thumb is that the price doubles in less than a year, after which an economic recession becomes the logical consequence. As with interest rates and bond yields; gradual rises are OK, rapid spikes not because they don't leave enough time for the world to prepare and to adapt.

So what's the situation right now? If we focus on the US$30/bbl bottom reached in February 2016, the price of oil has now more than doubled in around two years. But one has to take into account that for most of the period crude oil futures have been trading inside the US$50-60/bbl zone, so while today's US$70+ prices represent an extra burden for the global economy, it's not quite the same as the price rallying all the way to US$147/bbl ten years ago.

If we do get back above US$90/bbl and the market sets its sight upon three digits again, that will be the time to really start worrying. In the meantime, I have spotted the first few economists who now believe the brakes are on for global economic growth, because the twelve months gain is about 40% and one has to admit, the odds still seem in favour of higher oil prices.

Morgan Stanley, too, uses strong gains for energy prices as an important input for its relatively benign outlook for risk assets in the year ahead. The chart below reminds everyone energy is a "classic late cycle performer".

The implication here is twofold: on one hand there could be a lot more outperformance on the horizon for Woodside Petroleum ((WPL)), Origin Energy ((ORG)), Oil Search ((OSH)), Beach Energy ((BPT)), and the likes; on a secondary level it also functions as the proverbial canary telling us this cycle might be in its final innings.

On Monday, oil price forecasters at Commonwealth Bank significantly raised their price estimates for the next 24 months, arguing problems and supply restraints in Venezuela and elsewhere are likely to keep an upward bias on global oil prices while demand in the short term will exert inelasticity. The latter means demand won't be negatively impacted in the short term.

CommBank's new oil price forecasts are for Brent to average US$79/bbl in 2018, and then US$86/bbl in 2019. Given these are averages, all of a sudden US$100/bbl doesn't seem out of the question.

Also, with Saudi Arabia's focus on IPO-ing 5% of the world's largest oil producer, Aramco, the forecasters believe the Kingdom of Saud will be more focused on its own shorter term interest, than on further out impact for the rest of the world. Better buckle up!


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