Three scenarios for oil

19 March 2020

With a recent change in policy in Saudi Arabia, investors should be aware that there will be a growing weakness for many nations that are heavily reliant on oil, with the possibility of unrest, according to Janus Henderson.

Under the first scenario for the oil market, investors would see dual shocks, Janus Henderson’s diversified alternatives team’s portfolio manager, Mathew Kaleel said.

Kaleel’s perspective was based on not only on dampening effect COVID-19 already had on the global economy with the severe consequences such as disruption in global supply chains and demand, but also took into account the fact that the ‘OPEC+’ (OPEC and Russia) agreement had broken down, with Russia walking away from the agreement and Saudi Arabia announcing its intention to oversupply the market.

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According to Kaleel, with lower prices, higher inventories and a lack of catalysts for the next 12 months for increased demand, only one thing was certain and that was that volatility would remain elevated and the market would trade towards a price resistance level of US$45-50/bbl.

“This is in stark contrast to the situation only a month ago where there was confidence that the major players would be disciplined in supporting oil prices above US$50/barrel,” Kaleel said.

“Value can be added in the energy (and broader commodity) space in a number of ways in the current environment, either via more dynamic positioning along the oil forward curve, or where possible, the ability to be over or underweight specific commodities. This includes either being long and short across a commodity forward curve, or being long one commodity and short another.

Henderson’s head of global natural resources, Daniel Sullivan, warned that Saudi Arabia had very aggressively changed policy, opting for a price war.

“A knock-on from this event will be weakness for many nations heavily reliant on oil production, along with the possibility of unrest. Meanwhile, consumers globally will have access to cheaper fuels,” he said.

When asked how he would be responding to the crisis, he said: “We have been neutral to negative on the prospects for oil for a while and have a large underweight position (-13%) to traditional oil and gas. Our total weighting is 17%, so we still have holdings in many other different sub-industries in the portfolio, with gold (about 15% of the portfolio) in particular doing well recently.

“Whilst cheaper oil may slow some switching to renewables, there is also a case that renewables stable rates of return will become more attractive to energy investors than a struggling traditional oil and gas sector with limited commodity price upside.”

According to Ashley Kopczynski, asset portfolio manager – credit and ESG, diversification becomes ‘your friend’ during shocks of this nature and, at time like these, markets could throw the baby out with the bathwater, indiscriminately selling securities in companies, regardless of quality and strength.

“We are looking to add high quality credit to our portfolios, which we consider are companies that continue to operate with strong market positions with high barriers to entry. These are companies that have demonstrated the ability to survive the sorts of economic and market shocks we are experiencing at the moment,” he said commenting on how to deal with the crisis.

“These are companies that have demonstrated the ability to survive the sorts of economic and market shocks we are experiencing at the moment.

“Credit market ‘shocks’ often occur in combination with a lack of liquidity in the corporate bond market leading to wider than usual bid/offer spreads. This can create opportunities for investors who are able to deploy cash and take advantage of this market dynamic.”

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