Oil prices to improve in first half of 2019

Emerging markets demand and supply cuts could lead to an oil price recovery

Ruth Saldanha 4 January, 2019 | 6:00PM
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Earlier this week, on the first trading day of 2019, crude-oil prices bounced more than 4%, before giving back some of the gains, to trade around US$55 a barrel. The gains came after a steep drop in prices from October 2018, when West Texas Intermediate Crude touched US$75 per barrel.

“After outperforming the broader market for most of 2018, the Morningstar Global Energy Index dropped 22% in the fourth quarter through Dec. 20, owing to the steep drop in oil prices that began in October,” Morningstar sector director Jeffery Stafford wrote in an analyst note.

Oil prices in Canada also gained. The Alberta government’s oil production cuts came into effect on Jan. 1, and as a result, the difference between Western Canadian Select and West Texas Intermediate oil prices was about US$12.50 per barrel on Wednesday afternoon, according to Calgary oil brokerage Net Energy, an improvement over the US$17.52 per barrel average for spot contracts for January delivery signed last month.

According to the National Energy Board, this differential averaged a discount of US$12.95 per barrel between 2015 and 2017, but in 2018, the differential averaged a discount of US$27.09, with a discount of US$50 per barrel on some trading days in October 2018.

“Oil has certainly had a tough go of it – in a sense it has played catch-up to an already dismal broader commodity sector performance from throughout 2018,” said Hans Albrecht, a vice president, portfolio manager and options strategist at Horizons ETFs Management (Canada). 

Albrecht pointed out that the bounce this week, while not very impressive, reflected optimism that large oil nations would cut production. “The fact is that China has been slowing for a while and I think Trump/China trade tensions proved to be the shoe drop required for oil to snap back to reality – down,” he noted.

Supply cuts to put pressure on prices

On Dec. 7, 2018, OPEC and its partners announced a deal to cut crude production by 1.2 million barrels per day beginning in 2019. OPEC will account for 800,000 barrels per day of the cut, with its partners, led by Russia, responsible for the remaining 400,000 barrels per day.

In 2018, Russian crude-oil production hit a post-Soviet-era high, exceeding 11.0 million barrels per day. This was still lower than the United States, which produced 11.6 million barrels per day in November.

“Oil nations have historically been undisciplined, and producing more oil is always a small white lie away from happening”, Albrecht cautioned, noting that global economies are slowing, and the withdrawal of massive central-bank stimulus can’t be underestimated as a factor in oil’s drop.

“As money comes out of growth and goes into value, we could see a nice bounce from U.S. and Canadian producers. If China finds its footing economically, we could see US$75 a barrel, but that’s a big 'if'. March is a deadline between U.S./China so we may see a technical bounce before then but nothing sustainable”, Albrecht said, adding that he expects oil in the mid-50s or even high-50s in the first half of 2019.

Drop in oil prices leads to some attractive stock prices

The more than 30% drop in oil prices from the 2018 peak has coincided with a period of weakness for broader equity markets, making energy stocks look much more attractive than they did when OPEC met in June 2018, Stafford said.

Horizons portfolio manager Nicolas Piquard who manages Horizons Enhanced Income Energy ETF (HEE), agreed.

“Long term, I think emerging markets are cheaper than U.S. markets and should perform better going forward, and as growing emerging-market economies are heavy users of crude oil, a recovery in those markets should be beneficial for oil prices,” Piquard said. He also pointed out that energy stocks only represent around 5% to 6% of the SPX 500 Index, which at its 2007 peak it was over 15%. The last time energy shares weighting in the SPX 500 was this low was in 1999 and 2003 and both were significant troughs in oil and energy share prices, Piquard noted.

“Given our bearish long-term oil outlook (we're still 15% below long-term consensus), we think investors are more likely to find value in the volume-driven areas of the sector, namely midstream and refining. Nonetheless, the recent sell-off has created buying opportunities for multiple integrateds, exploration and production companies, and services firms, too,” Stafford said.

Stafford’s top picks are Canadian midstream firm Enbridge (ENB), a rare triple threat, that boasts a wide Morningstar economic moat rating, an attractive 6.8% dividend yield, and a cheap valuation; Texas-based midstream natural gas and crude oil pipeline company Enterprise Products Partners (EPD); and the world’s largest oil services company, Schlumberger (SLB).

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Enbridge Inc46.47 CAD0.43Rating
Enterprise Products Partners LP27.73 USD1.74Rating
SLB59.19 USD0.62Rating

About Author

Ruth Saldanha

Ruth Saldanha  is Editorial Manager at Morningstar.ca. Follow her on Twitter @KarishmaRuth.


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