Noble Apex eNewsletter Issue 792- Is current oil price undervalued relative to the fundamentals?

2019-01-21 04:30
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21 January 2019 Issue 792

Global Market Commentary

Equity

  • US: China proposes to increase annual imports of US goods by $1 trillion, implying that Sino-US trade tension may ease. For the entire week, the Dow rose by 2.96% to 24,706.35. The S&P 500 index rose by 2.87% to 2,670.71. The Nasdaq rose by 2.66% to 7,157.23 points.
  • Europe: It is reported that U.S. Treasury Secretary Nuchin is considering to remove tariffs on Chinese goods. The market expected that the Sino-US trade tension will be eased. Besides, the British government has actively find for consensus on the Brexit issue, which is beneficial to the stock markets. Over the week, the UK’s FTSE 100 index rose by 0.72%, the German DAX index rose by 2.92%, and the French CAC40 index rose by 1.98%. The STOXX 600 index rose by 1.69% to 349.20 points.
  • Asia: It is reported that U.S. Treasury Secretary Nuchin is considering to remove tariffs on Chinese goods. The market expected that the Sino-US trade tension will be eased. For the whole week, the Nikkei 225 index rose by 1.50% to 20,666.07 points. The MSCI Asia Pacific Index rose by 1.19% to 153.35.

Bonds

  • US: The market expected that the Sino-US trade war will be eased, global stock markets rebounded, and capital flowed out from the bond market, bond prices fell, and yields rose. For the whole week, the yield on the US 10-year government bond rose by 3 basis points to 2.784%.
  • Europe: The House of Commons of the United Kingdom vetoed the Motion of no confidence on the British Prime Minister Wen Cuishan’s government and proposed to assist UK to leave the EU orderly, reducing the need for capital hedging. For the whole week, the German 10-year bond yield rose by 3 basis points to 0.237%.

Commodity

  • Oil: The Organization of Petroleum Exporting Countries explained the oil reduction plan in detail, and published a list of production reduction quotas for member states and other major oil producing countries. Over the week, New York oil futures rose by 4.28 percent to close at $53.80 a barrel.

Currency

  • US dollar: It is reported that U.S. Treasury Secretary Nuchin is considering to remove tariffs on Chinese goods, which lowered the market’s worries about Sino-US trade wars. For the entire week, the Dollar Index rose by 0.696% to 96.336.
  • China: Although the Sino-US trade war has eased, the United States may file a lawsuit against Huawei. The Sino-US science and technology war has affected market confidence towards Renminbi. For the whole week, the yuan fell by 0.517% against the US dollar to 6.776.

 

Economic-related News

  • US President Trump agreed to have the second meeting with North Korean leader Kim Jong-un at the end of February. It is reported that the summit will be held in Vietnam.
  • U.S: Trump announced the first substantive proposal since the government shut down. He suggested to extend the DCAC plan and TPS plan for three years in exchange for a $5.7 billion wall construction fee. But the proposal was rejected by the Speaker of the House of Representatives.
  • U.S: New York Fed President Williams said that the government’s suspension may lead to a 1% decline in economic growth rate.
  • U.S: US University of Michigan consumer confidence index fell to 90.7 in January, hitting a two-year low. It is lower than the expectation of all Bloomberg’s economists.
  • Euro-zone: British Prime Minister Theresa May will submit a Brexit option plan on Monday. It is reported that there is likely no progress in cross-party negotiations. May will seek to amend the terms of the Brexit agreement on the Irish border issue.
  • Euro-zone: Canadian Minister of Public Safety claimed that security review on 5G technology will continue, including the decision on whether to boycott Huawei, and Canada will not sacrifice national security.
  • Euro-zone: The Italian central bank has lowered its forecast for economic growth of the coming two years, and hinted that the euro zone’s third-largest economy may have fallen into recession by the end of 2018.
  • Japan: The Ministry of Economy, Trade and Industry announced that Japan’s industrial production index fell by 1% from the previous value of 2.9% increase in December last year, to 104.8.
  • Japan: Japan’s Ministry of Internal Affairs and Communications announced that Japan’s consumer price index (CPI) rose by 0.8% year-on-year to 0.3% in December last year, which is similar with market expectations.
  • Singapore: Singapore’s International Enterprise Development Agency (IE Singapore) announced that Singapore’s non-oil exports (NODX) have fell for two months in December last year, which is lower than market expectations of 2% increase. Also, the decline rate has expanded to 8.5% year-on-year.

 

China Market Commentary
Economic-related news
• According to informed person, China proposes to increase the annual import of US goods by more than US$1 trillion within six years, hoping to eliminating trade surplus with the US by 2024.
• China will release important economic data today. The fourth-quarter GDP growth rate is expected to slow down from 6.5% in the third quarter to 6.4%, which will be the slowest growth rate since 2009.

 

Is current oil price undervalued relative to the fundamentals?

After the collapse and volatile late-2018, exacerbated by low liquidity, Brent crude oil prices have had a strong rally since the Christmas Eve. It was mainly driven by the news that OPEC and allied oil producers including Russia to cut production by 1.2 million barrels per day (bpd) and will take further action when necessary. On the demand side, Chinese stimulus and trade talks between official from the US and China has brought hope for a more stabilised global economy in 2019. So, after increased by 15% YTD at around $61/bbl, the key question: the current price levels and term structure remain undervalued relative to the fundamentals?孑

A recent research from Goldman Sachs looks relatively positive in first glance and says it won’t be “hoodwinked” again on commodities and suggests investors to buy into this year’s comeback story in oil. According to his top-down global oil demand growth model, the oil market (Brent at $57.06 when the report issued) only pricing in a global GDP growth at 2.5% YoY in 2019, which is much below its 3.5% forecast and still excessive even if accounting for the December activity indicators that global GDP growth may down to 3.2%. Besides, given the fiscal strains, OPEC would likely cut the production more if global GDP really disappoints to that level. On the demand side, it forecasts 2019 global oil demand growth of 1.4 mb/d (assumes global GDP growth at 3.3%), with a 60 kb/d downward revision to Chinese demand growth, while EM demand outside of China, such as Brazil, Turkey, South Africa and Russia will recover in 2019.

 

Figure 1.  Production was down from November before the cuts are even implemented

Source: Goldman Sachs, Noble Apex/iFund, Kpler

However, on a 1-year and longer term prospective, the report actually suggest a more cautious outlook and expects the earlier than expected new pipelines to release the low-cost Permian basin into the global market in 2H19, requiring a lower marginal cost to balance the oil market in 2019. In addition to a higher inventory levels from the start of 2019, the low-cost production capacity is also increasing globally, plus the capacity in Permian Shale oil rises even faster amid weaker than expected shale cost inflation.  What’s more, the delayed long-cycle projects in Brazil and Canada is ramping up too.

All in all, forecasting the crude oil supply and demand is not easy for both professionals and individual investors, in particular US is the only source of up-to-date inventory numbers and the rest of the world is comparatively opaque regarding its inventory and production level, and some  producers always adjust their production much earlier than the news released. In fact, a different way is to look at the degree and the slope change of the contango/backwardation (i.e. an upward/downward sloping forward or future price curve) in the oil market as an indicator of whether or not prices have hit bottom or peak. It could be more reliable as the forward market is generally participating by the oil majors that indicate the actual demand and supply of long term.

 

Figure 2. When super contango happens, oil price generally increase afterwards

Source: Ned Davis Research

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