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Why Opec oil deal is not FTSE's saviour

Oil prices leaped on back of Opec's agreement to cut production yet UK's commodity-laden stock market has fallen. Why? 

Why Opec oil deal is not FTSE's saviour

This week’s historic deal by Opec oil-producing nations to cut production saw the price of crude leap over 18% but has left investors debating the wider impact on energy companies and the broader stock market, which has fallen with the FTSE All Share index down nearly 2%.

The price of Brent crude – one of two main global measures of oil – jumped from just over $46 to $54.51 close to a two-year high on Thursday before slipping back on Friday to $53.25.

The decisive leap through the $50 level gave a boost to oil producers, including FTSE giants BP and Royal Dutch Shell, who have struggled to slash costs and curb their own output since oil prices slumped from a peak of $115 in June 2014, hitting a low of just $30 at the start of this year.

Opec surrender

This week’s agreement reverses the Saudi Arabia-led decision in mid-2014 to maintain Opec output despite signs of global economic weakness and falling demand.

The strategy at the time was to force down the price of oil and punish US shale-oil and gas producers who threatened Opec’s dominance by making the US energy independent and far less reliant on oil imports.

While the shift to ultra-low oil prices did force some US shale companies out of business, overall the industry proved surprisingly resilient, finding new ways to become more efficient. Their shares shot up this week as the stock market viewed Opec’s move as a surrender and a recognition that their own economies were suffering.

Although a retreat, the Opec agreement was an achievement for a fragmented group that historically has struggled to find consensus. The decision to cut the number of barrels of oil produced per day by 1.2 million to 32.5 million from the start of next year marks the first cut in output since 2008. Equally significant was the fact that Russia, a non-Opec country, also agreed to a new quota for the first time in 15 years, making it a bit more likely the agreement will be stuck to.

Deal could stick

Bob Minter, investment strategist at Aberdeen Asset Management, said it was possible that oil could now increase to between $56 and $60 per barrel, which would further relieve the financial pressure on producers and explorers.

More significant than that though was the fact that Opec had come together, he said: ‘People were seriously starting to question Opec’s ability to react to what has been going on in the oil market and this reaffirms their ability to act as a group,’ he said.

Roberto Cominotto, manager of the JB Energy fund at GAM, was positive about prospects. He expected global oil supply would stagnate or slightly decline over the next three to four years and believed this would keep the oil market in a tight supply situation until the end of the decade and possibly beyond.

‘Market participants are sceptical that the oil price recovery can continue on fears of US shale oil flooding the market when prices approach $50.

‘In our view, this overestimates the impact of US shale oil production on the global oil market. Representing only 5% of global oil production, US shale oil producers would need to grow their output at a dramatic rate to have a strong impact on the global oil market,’ he explained.

Doubts remain on oil majors

Ben Kumar, investment manager at Seven Investment Management, said the Opec deal was generally positive for the FTSE 100 as it benefited not just energy companies but also miners and other commodity-related businesses that make up a large proportion of the UK index.

However, while shares in BP (BP) and Shell (RDSb) spiked on Wednesday, overall they notched up modest gains during the week. With both stocks offering high yields of 7%, investors clearly remain concerned about their ability to pay big dividends while oil remains below $60 a barrel.

‘The concerns [over dividends] are not crossed out,’ Kumar said. ‘The oil price is still half of what it was two-and-a-half years ago.’

‘I would be loath to say [the oil companies] are out of the woods yet. There is a long way to go,’ he added.

Inflation fears hit dividend stocks

This caution extended to the rest of the stock market. Despite being a commodity-heavy index the FTSE 100 fell over the week as the prospect of higher oil prices added to concerns over rising inflation following the election of Donald Trump and his promise to spend up to $1 trillion on US infrastructure.

Chris Beauchamp, chief market analyst at IG, an online trading platform, said: ‘The hardest hit have been the stalwart dividend plays that served the index, and investors, so well in the post-Brexit period.

‘Now, in the brave new world represented by Donald Trump, fear of higher inflation that will eat into margins for the likes of Compass (CPG), Unilever (ULVR) and the rest is resulting in investors moving to oil and financial stocks. The former on the back of the Opec deal, which is curiously holding up nicely so far, while financials rise on expectations of higher interest rates.’

While great uncertainty remains over Trump’s intentions as US president, investors dampened down expectations that oil would regain its previous highs and force inflation much higher for a sustained period of time.

Oil demand questioned

Aberdeen’s Minter pointed to the geopolitics around the Paris climate change treaty signed last year. ‘Greatly increased demand for oil is not necessarily a given in the years to come. Trump might try to tear up the Paris accord but it’s the likes of India and China that matter the most and they don’t want to rely on oil.

‘Opec is going to need to harness all of its powers of co-ordination and bargaining to chart this existential threat,’ he said.

Dominic Rossi, chief investment officer at Fidelity International, said investors should ‘not get too excited’ by the Opec cut and should wait to see how the agreement plays out in reality.

‘Compliance will be a problem, and the Russians will pump more gas instead,’ he said. ‘In the meantime, the long-run marginal cost of US shale continues to fall. I would not chase this oil price rally too hard.’

1 comment so far. Why not have your say?

Anonymous 1 needed this 'off the record'

Dec 03, 2016 at 09:39

matchmaker , matchmaker make me a match, lots of oil out there and too many managers, isnt it easy to mention them in the same breath ?

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FTSE battles against wave of UK profit warnings

by Michelle McGagh on Jun 19, 2018 at 09:53

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