Dollar continues to climb, EPA increases bio-fuel requirements
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25/11/2016
 

Saudis Withdraw From Non-OPEC Meeting, But Odds For Deal Are Still Good

 
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Oil prices fell on Friday morning after some bearish comments from Saudi Arabia, but the odds of a substantial OPEC deal seem to have improved now Iraq is on board.

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Friday, November 25, 2016

Oil prices held steady just below $50 per barrel at the end of the week, before falling back a bit as a result of bearish
Saudi rhetoric. Iraq added momentum to the market in the lead up to the Vienna summit, agreeing to shoulder some of the burden for the cartel’s production cuts. After resisting for weeks, Iraq’s Prime Minister said that his country will participate. “Iraq will cut its output to preserve prices,” Al-Abadi told reporters in Baghdad on November 23. Iraq was one of the largest stumbling blocks to a deal, so things are looking pretty good for some sort of agreement next week. If they succeed, the deal would take effect in January.

OPEC by the numbers. To fall into the range that OPEC set out in Algiers – between 32.5 and 33.0 million barrels per day – OPEC will need to cut between 600,000 and 1.1 million barrels per day. Taking the midpoint, or about 900,000 barrels per day, would go a long way to erasing the global supply surplus.

However, Saudi Arabia is reportedly
on board with an aggressive approach: Making cuts of 1.1 mb/d in order to take output down to 32.5 mb/d, plus asking Russia and other non-OPEC countries to contribute another 500,000 to 600,000 barrels per day in reductions. If that were to occur, the agreement could take 1.6 percent of global supplies off the market. OPEC has surprised and disappointed the oil markets many times in the past two years, so nothing should be taken for granted. But if a deal is signed, oil prices could rise substantially. A survey of analysts conducted by The Wall Street Journal finds that oil watchers think prices would rise to $55 per barrel if OPEC succeeds, but could fall to $40 per barrel or less if they don’t. Needless to say, the stakes are high. 

 
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Rising oil prices a boost to U.S. shale. IEA executive director Fatih Birol sees oil prices climbing to about $60 per barrel if OPEC succeeds in cutting output. That would be a boon to OPEC but it could also provide a spark to U.S. shale, which is already holding up with oil prices below $50 per barrel. Production from the Permian basin in particular will continue to soar if oil prices rise. Already very profitable at today’s prices, the Permian has captured a growing share of global oil investment this year. If output from the U.S. rises, the IEA says the OPEC deal could lead to another downturn in prices within nine months to a year. In other words, the OPEC deal may only provide a short-term boost to prices, which will lead to higher output and another downturn. 

Dollar continues to climb. The markets are
expecting a near 100 percent chance that U.S. Fed Chair Janet Yellen hikes interest rates in December, with further action expected next year. That is pushing up the value of the dollar and leading to losses for emerging market currencies around the world. The dollar is at its strongest level against a basket of other currencies since 2003, forcing central banks around the world to respond to protect the value of their currencies. The stronger dollar is providing a check on rising commodity prices – oil fell on Friday because of gains for the greenback. 

China provides aid to Venezuela, takes more oil. Cash-strapped Venezuela turned to China for financial assistance, and China
agreed to invest $2.2 billion in the South American OPEC member in exchange for a higher take of its oil production. Due to past investments, Venezuela has been sending some 550,000 barrels per day to China. Between 2007 and 2015 China poured about $65 billion into Venezuela and has been paid back in oil. After the latest agreement is signed in December, China will have the rights to 800,000 barrels per day of Venezuelan oil. The Chinese investment could help stabilize Venezuela’s output by upgrading infrastructure. 

Peak oil demand. The Economist
added its voice to the growing chorus regarding the prospect of a peak in oil demand. The magazine argues that the world needs to prepare for a post-oil age, even if that era is not yet upon us. Instead of a sharp decline in consumption, The Economist says that the end of oil will be more gradual, and largely due to a shift in investment away from fossil fuels and into alternatives. 

OPEC cuts could hurt tanker industry. Fewer tankers filling up and departing from the Middle East will put a dent in the business for oil tankers. Bloomberg
estimates that the proposed cuts from OPEC would reduce the equivalent of five supertankers’ worth of crude oil. This comes at a time that the tanker business is struggling from an expanding tanker fleet, which is putting pressure on day rates. Plus, higher oil prices could slightly slow crude oil demand, which could further reduce oil trade. 

EPA increases biofuel requirement. The U.S. EPA
released final numbers for its 2017 biofuel mandate, handing the oil industry a huge loss. The EPA will require 19.28 billion gallons of biofuels to be blended into the U.S. fuel supply, much higher than the 18.8 billion gallons the agency proposed in May. The figures will require 15 billion gallons of corn-based ethanol and 4.28 billion gallons of more advanced biofuels. The battle over the renewable fuels mandate is one that pits powerful Midwestern farmers against the oil industry.  

In our Numbers Report, we take a look at some of the most important metrics and indicators in the world of energy from the past week. Find out more by
clicking here

Thanks for reading and we’ll see you next week. 

Best Regards,

Evan Kelly
Editor, Oilprice.com

P.S. – Technical analyst Jim Hyerczyk sees the odds of an OPEC deal improving. The fact that Iraq is now on board could be a decisive factor. Markets are also getting increasingly optimistic that OPEC will come forward with a substantial deal as buying signals that some major speculators are now doubling down on an output cut. Get a clue about where oil is headed by claiming your 30 day risk-free trial on
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What's in Oil & Energy Premium this week:
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• How To Play The OPEC Production Cut
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Inside Markets:
• Big Money Betting On An OPEC Deal Next Week
Inside Intelligence:
• Global Energy Advisory November 25th 2016
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Is This The Time To Buy Energy Bonds?

With the election of Donald Trump as President, the bond market is seeing a tremendous amount of turmoil among high quality issues. Interest rates on the long end have risen substantially as investors anticipate faster economic growth and higher inflation. All of this has led investors to shift out of bonds and into equities at a rapid pace. Energy investors following suit might be making a mistake.

Energy bonds these days are often short term debt with only a few years until maturity and relatively high interest rates. The debt for many energy companies is often sub-investment grade as well. Energy investors are making a mistake by giving up on such debt too easily. 

While it is true that a rapid rise in interest rates would hurt the value of all existing bonds, energy bonds are probably better insulated than most. For one thing, by issuing short term debt the bonds have limited exposure to duration risk (i.e. interest rate risk). 

More importantly, interest rates are not going to stay elevated unless the economy picks up steam, and if the economy picks up steam then oil prices will rise as well. Oil prices have been low as much because of lackluster demand as because of excess supply, and a stronger economy will help cure that demand shortage. And of course if oil prices pick up, then that will boost the financial stability of all but the weakest of energy companies which in turn should help lift bond prices.

The conclusion one might draw then is that investors in energy debt are in a no-lose situation. If the economy stays weak, any rise in interest rates or inflation will be temporary and limited. As a result, while bonds might lose a bit of value in the short term, in the medium term they should bounce back nicely. 

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Some investors may be concerned about inflation, but that’s mostly a red herring. Inflation is directly correlated to economic growth at low levels – that is weak growth is correlated with weak inflation and strong growth is correlated with strong inflation. This breaks down at higher levels of inflation – such as what Venezuela or Iran has seen lately – but that’s not a situation that’s relevant to the US or the developed world.

If the economy really does start growing faster under Trump, then energy companies will be direct beneficiaries. The industry is one of the few with excess capacity, and many oil companies would fare dramatically better over the next few years if the broader economy were growing at 3% instead of 1.5%.

To capitalize on opportunities in this space, investors should consider some of the bond ETFs that are available. Aggregated bond ETFs can offer investors attractive yields based on the level of risk one is willing to take. The data from Barclays below illustrates this.


 
Source: Barclays, S&P 9/30/2016

For those who are confident of an improving economy and rising rates, one interesting opportunity in the fixed income space at this point is in floating rate notes. Floating rate notes for the energy sector are not all that common, but there are a few. Floating rate senior bank loans in the energy sector for instance can be accessed indirectly through various bank loan ETFs like those from Powershares and Blackrock. 

These floating rate energy sector bank loans will get a double boost from a successful Trump Presidency. Higher interest rates will lead to higher levels of income and a stronger economy will make energy companies able to afford higher levels of interest. 

The converse of course is that if the economy fails to strengthen as expected, floating rate notes will lose value due to interest rates falling back, and energy companies will be left with a weak demand environment. For now, floating rate notes look very compelling though as their rates are often based on LIBOR which has been rising consistently in recent months.


 
Energy investors have a lot to be thankful for this Thanksgiving, but they also have a lot to consider about asset allocation going forward. With the end of the year upon us, this is the time to harvest taxable gains and losses, so the allocation question is a conversation smart investors should start having now. 
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