Investment Strategy  

09/06/2017

Towards a range-bound, yet volatile oil price

Petrole_Intranet-M.JPG

The Organization of Petroleum Exporting Countries’ (OPEC) decision to extend its production cut for a further 9 months came as a relative disappointment to markets, that had been hoping for a more aggressive outcome (deepened cuts and/or more detail on the exit strategy). But it comforted our baseline scenario of a gradual rebalancing of the oil market over the course of the year.

In this Bulletin, we take the opportunity of the recent OPEC news to delve deeper into the details of our scenario of a range-bound yet volatile oil price for several years to come. We see actions taken both by the OPEC and the US shale industry as likely to keep the barrel within a USD 45-60 range, with an average price of around USD 55/bbl in 2017 and 2018 (Brent).

Indeed, with OPEC facing no other rational choice but to stay committed to its “rebalancing act” and maintain a floor on the oil price by restraining production, the most sensitive variable in the equation remains the production cost of the US shale industry or, put differently, the oil price level that triggers investment in new production capacities / production shutdowns.

With the oil price currently at the lower end of this range, we would recommend maintaining exposure to commodities and relative assets. Not only does the downside appear limited, but favorable seasonality also lies ahead. Yet, expect prices to remain volatile as long as the physical market is oversupplied.

OPEC vs shale industry: if you can’t beat them then learn to live with them.
On May 25 the cartel announced that the output curbs set at its prior meeting will be prolonged for nine months, in attempt to end the oil glut in place since end 2014 and rebalance the global market, after the halving of oil prices decimated oil-dependent producers’ budgets. The output cuts by the 12 OPEC and 10 non-OPEC countries (led by Russia) were extended with unchanged volumes and continued Libya/Nigeria exemptions. While compliance will be scrutinized given OPEC’s long history of underperformance, it has actually proved high during the first five months of agreement.

The five-year rolling average of OECD1 inventory was referred to as a key performance indicator, the normalisation of stocks being a required first step for market stabilisation. In this respect, first signs of improvement materialized a few weeks ago in high-frequency data provided by the EIA on US stocks. Interestingly, the latter started to fall even before the start of the driving season. Markets will be keeping a close watch though, due to i/ the still high level of OPEC exports to OECD countries, and ii/ the surprisingly healthy return of US production (more below).

Although some OPEC members (notably Saudi Arabia) still have fiscal breakevens well above USD 60/bbl, they seem relatively satisfied with the oil price improvement since 2016. Indeed, the prospect of only a small production cut resulting in a revenue increase thanks to higher prices has succeeded in keeping all countries, even Iraq and Russia, on board so far.

As the main contributor to the deal, the situation of the Kingdom of Saudi Arabia is key. With its reserves having dropped another 5% in 1Q17 and now standing just above USD 500 bn (down 32% from their mid-2014 peak), financial stress remains elevated. And while efforts are being made on the fiscal front to adapt to the new oil price paradigm, the current fiscal breakeven (USD 74/bbl in 2018 according to the International Monetary Fund -IMF) suggests that reserve drawdown should continue in coming years. That said, the use of Saudi financial reserves can be seen in a more structural perspective. Indeed, medium term, Saudi Arabia’s ambitious annual budget depicted in the National Transformation Plan aims to more than double non-oil revenue. Should this adjustment process prove successful, the Kingdom would be able to reduce its oil breakeven below USD 50/bbl by 2020, assuming production remains stable at 10 million barrels per day.

This year’s resurgence of US shale production has already well exceeded main agencies’ expectations. As such, the US Energy Information Administration (IEA) has revised its 2017 and 2018 year-end shale output forecasts up by respectively more than 450’000 and almost 900’000 barrels per day, whilst keeping its price assumptions unchanged. Implicitly, this suggests that the marginal cost of the US shale industry, i.e. the price level that makes investment in new fields possible and triggers additional production, is lower than originally thought. Most recent estimates2 suggest that after several quarters of cost-cutting and bankruptcies (the default rate reached 25% last year), the shale industry is now more homogenous, with marginal costs ranging between USD 52 and USD 59/bbl – as compared to a higher and much wider USD 57 to 90/bbl just five years ago. Any long-lasting period of 12- to 24-month forward WTI contracts above USD 60/bbl would thus result in additional US supply within 6-9 months.

To contain OPEC member frustration and avoid that their efforts ultimately only help to accelerate the US shale comeback at the expense of their own market share, it will be crucial for the organization to monitor the shape of the forward curve. Once inventory drawdowns are well engaged, the threat posed by OPEC spare capacities should help sustain forward curve backwardation and, in turn, restrain US shale companies’ financing.
For now, while recognising that there is a risk that quotas be relaxed, whether due to geopolitical tensions between OPEC members or mounting frustration regarding the US shale recovery, our baseline scenario is that the OPEC agreement – and, maybe more importantly, the Saudi Arabia – Russia coordination - will hold at least until 2018.

On the demand side, an upside surprise looks possible as emerging market consumption rebounds after several quarter of sluggish economic growth. Combining the forecasts of the three main agencies (IEA, EIA and OPEC) suggests that global 2017 oil demand should be roughly in line with its historical average. Unsurprisingly, most of the incremental demand is to come from non-OECD countries (over 1.2 million barrels per day). Yet, this estimate remains quite conservative in our view. The recovery in emerging markets should really gain traction this year, notably in Brazil and Russia. We would thus not be surprised to see actual data overshooting forecasts. But as long as inventories have not been drained, this would only translate into an acceleration of the oil market rebalancing. We do not think it is liable to push oil prices durably above USD 60/bbl.

Bottom line, we expect Brent to average USD 55/bbl in 2017-2018. For the second half of this year, this means significant upside to the spot price. With the driving season just beginning, seasonality should also prove supportive, while the slope of the forward curve should no longer be a deterrent. Sentiment could also turn more positive with money just starting to flow back into commodity funds and multi-asset portfolios still broadly underweight. Finally, after several attempts since mid-2016, the neutral speculative positioning, close to its long-term average, could also support oil prices. But the volatility of this asset class calls for nimbleness and a close monitoring of trades as a USD 10/bbl rise might be achieved in only a few weeks.

More generally, our baseline scenario of an oil price floored by the OPEC and capped by the US shale industry, along with the stability of the Chinese economy, is an important support factor for the emerging world initiated a year ago.


1 Organisation for Economic Co-operation and Development
2 See “Top Projects 2017”, Goldman Sachs Equity Research

Important information

This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier. Accordingly, it has not been in accordance with the Swiss Bankers Association Directives on the Independence of Financial Research or any other legal requirements designed to promote the independence of investment research. Any information contained in this document is not and should not be regarded as financial research for the purposes of the Swiss Bankers Association or any relevant regulatory body. Consequently, this document is not subject to any restriction on dealing head of the dissemination of investment research. Furthermore it is duly stressed that opinions expressed in this document may differ from the opinions expressed by other divisions of Lombard Odier, including its Financial Research Department. This document is provided for information purposes only. It does not constitute an offer or a recommendation to subscribe to, purchase, sell or hold any security or financial instrument.

It contains the opinions of Lombard Odier, as at the date of issue. These opinions and the information contained herein do not take into account an individual’s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes a personal recommendation to any investor. Each investor must make his/her own independent decisions regarding any securities or financial instruments mentioned herein. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Lombard Odier does not provide tax advice. Therefore you must verify the above and all other information provided in the document or otherwise review it with your external tax advisors.

Investments are subject to a variety of risks. Before entering into any transaction, an investor should consult his/her investment advisor and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. The information and analysis contained herein are based on sources considered to be reliable. However, Lombard Odier does not guarantee the timeliness, accuracy, or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices, market valuations and calculations indicated herein may change without notice.

Past performance is no guarantee of current or future returns, and the investor may receive back less than he/she invested. The investments mentioned in this document may carry risks that are difficult to quantify and integrate into an investment assessment. In general, products such as equities, bonds, securities lending, forex, or money market instruments bear risks, which are higher in the case of derivative, structured, and private equity products; these are aimed solely at investors who are able to understand their nature and characteristics and to bear their associated risks. On request, Lombard Odier will be pleased to provide investors with more detailed information concerning risks associated with given instruments.

The value of any investment in a currency other than the base currency of a portfolio is subject to the foreign exchange rates. These rates may fluctuate and adversely affect the value of the investment when it is realised and converted back into the investor’s base currency. The liquidity of an investment is subject to supply and demand. Some products may not have a well-established secondary market or in extreme market conditions may be difficult to value, resulting in price volatility and making it difficult to obtain a price to dispose of the asset.

If opinions from financial analysts are contained herein, such analysts attest that all of the opinions expressed accurately reflect their personal views about any given instruments. In order to ensure their independence, financial analysts are expressly prohibited from owning any securities that belong to the research universe they cover. Lombard Odier may hold positions in securities as referred to in this document for and on behalf of its clients and/or such securities may be included in the portfolios of investment funds as managed by Lombard Odier or affiliated Group companies.

European Union Members: This document has been approved for use by Lombard Odier (Europe) S.A., a credit institution authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg and by each of its branches operating in the following territories: Belgium: Lombard Odier (Europe) S.A. Luxembourg • Belgium branch, a credit institution supervised in Belgium by the Banque nationale de Belgique (BNB) and the Financial Services and Markets Authority (FSMA); France: Lombard Odier (Europe) S.A.• Succursale en France, a credit institution supervised in France by the Autorité de contrôle prudentiel et de résolution (ACPR) and by the Autorité des marchés financiers (AMF) in respect of its investment services activities; Italy: Lombard Odier (Europe) S.A. • Italian Branch, credit institution governed in Italy by the Italian stock market regulator (Commissione Nazionale per la Società e la Borsa , or CONSOB) and the Bank of Italy; Netherlands: Lombard Odier (Europe) S.A. • Netherlands Branch, a credit institution supervised in the Netherlands by De Nederlandsche Bank (DNB) and by Autoriteit Financiële Markten (AFM); Spain: Lombard Odier (Europe) S.A. • Sucursal en España, a credit institution supervised in Spain by the Banco de España and the Comisión Nacional del Mercado de Valores (CNMV); and United Kingdom: Lombard Odier (Europe) S.A. • UK Branch, a credit institution in the UKsubject to limited regulation in the UK by the Financial Conduct Authority (‘FCA’) and the Prudential Regulation Authority (‘PRA’). Details of the extent of our authorisation and regulation by the PRA and regulation by the FCA are available from us on request. UK regulation for the protection of retail clients in the UK and the compensation available under the UK Financial Services Compensation Scheme does not apply in respect of any investment or services provided by an overseas person.

In addition, this document has also been approved for use by the following entities domiciled within the European Union: Gibraltar: Lombard Odier & Cie (Gibraltar) Limited, a firm which is authorised and regulated by the Financial Services Commission, Gibraltar (FSC) to conduct banking and investment services business; Spain: Lombard Odier Gestión (España) S.G.I.I.C., S.A.U., an investment management Company authorised and regulated by the Comisión Nacional del Mercado de Valores (CNMV).

Switzerland: This document has been approved for issue in Switzerland by Bank Lombard Odier & Co Ltd Geneva, a bank and securities dealer authorized and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

United States: Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term “United States Person” shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.

This document may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Lombard Odier. 

Actualités

Marchés émergents - La Chine étend son hégémonie

Quarterly Investment Strategy

20/07/2017

Japan - Difficile de faire mieux

Quarterly Investment Strategy

19/07/2017

La gouvernance familiale repensée

Thought leadership

18/07/2017

Europe - L’euroscepticisme a moins la cote

Quarterly Investment Strategy

17/07/2017

Etats-Unis - Ni inflation, ni récession

Quarterly Investment Strategy

12/07/2017

Bilan à mi-année : jusqu’ici tout va bien

Quarterly Investment Strategy

10/07/2017

Perspectives d'investissement - 3e trimestre 2017

Perspectives d'investissement - 3e trimestre 2017

Investment Strategy Podcast

06/07/2017

RETHINK EVERYTHING

Thought leadership

28/06/2017

Les philanthropes, la finance et la cité

Thought leadership

20/06/2017

RETHINKING EDUCATION

Thought leadership

15/06/2017

RETHINKING HEALTHCARE

Thought leadership

31/05/2017

Rethinking “Next-Gen” Philanthropy

Thought leadership

24/05/2017

Gestion des fondations en transformation

Thought leadership

23/05/2017

L’investisseur « 100% impact »

Thought leadership

19/05/2017

Asset Allocation – Maintenir un biais positif

Quarterly Investment Strategy

18/05/2017

Elections françaises - stratégie d'investissement

Elections françaises - stratégie d'investissement

Investment Strategy Podcast

10/05/2017

Elections présidentielles françaises

Investment Strategy

08/05/2017

Hedge funds and rising interest rates

Investment Strategy

01/05/2017

Elections françaises

Elections françaises

Investment Strategy Podcast

25/04/2017

Elections présidentielles françaises

Investment Strategy

24/04/2017

Japon: La question de la longévité

Quarterly Investment Strategy

24/04/2017

Europe: Vers la fin des taux négatifs ?

Stratégie de placement trimestrielle

21/04/2017

Le Pen, Frexit and the future of the EU

Investment Strategy

10/04/2017

Perspectives d'investissement du 2ème trimestre 2017

Perspectives d'investissement du 2ème trimestre 2017

Investment Strategy Podcast

03/04/2017

Obligations climatiques: il faut rester vigilant

Nos experts dans la presse

01/04/2017

Le franc, refuge des élections en Europe

Nos experts dans la presse

16/03/2017

Rethinking sustainable cities with Monocle

Rethink everything

24/02/2017

Brexit : survivre en dehors du marché unique ?

Stratégie d'investissement

19/01/2017

Japon : un gagnant « accidentel » ?

Stratégie de placement trimestrielle

29/12/2016

Marchés émergents : La reprise ne fait que commencer

Stratégie de placement trimestrielle

28/12/2016

Europe: encore d’importants risques politiques à l’horizon

Stratégie de placement trimestrielle

23/12/2016

États-Unis : une cure de vitamines pour une économie fatiguée

Stratégie de placement trimestrielle

22/12/2016

Perspectives d’investissement 2017

Perspectives d’investissement 2017

Investment Strategy Podcast

19/12/2016

OPEC rises from the ashes

OPEC rises from the ashes

Investment Strategy Podcast

04/12/2016

Diabète : une technologie révolutionnaire

Révolution thérapeutique

18/11/2016

Élections américaines : perspectives d'investissement

Élections américaines : perspectives d'investissement

Investment strategy podcast

16/11/2016

Positioning portfolios for President Trump

Positioning portfolios for President Trump

Investment strategy podcast

10/11/2016

Donald Trump elected President

Investment Strategy

09/11/2016

Perspectives élections américaines

Perspectives élections américaines

Investment Strategy Podcast

24/10/2016

Perspectives d'investissement du 4e trimestre 2016

Perspectives d'investissement du 4e trimestre 2016

Investment Strategy Podcast

21/10/2016

Japon : Seul en première ligne

Stratégie de placement trimestrielle

19/10/2016

Un dernier trimestre placé sous le signe de la politique

Stratégie de placement trimestrielle

07/10/2016

Philanthropie : l'indispensable mue

Philanthropie

20/09/2016

SOUTIEN FISCAL : LE GRAND RETOUR ?

Stratégie d'Investissement

01/09/2016

LE RETOUR DE LA « CÉLÈBRE BoJ »

Stratégie d'investissement Asie

09/08/2016

L’OR EST-IL RÉELLEMENT UNE BONNE COUVERTURE ?

Bulletin de stratégie d'investissement

22/07/2016

DES RISQUES POLITIQUES ET DES LEVIERS ÉCONOMIQUES

Stratégie de placement trimestrielle

14/07/2016

PERSPECTIVES D’INVESTISSEMENT DU 3e TRIMESTRE 2016

PERSPECTIVES D’INVESTISSEMENT DU 3e TRIMESTRE 2016

Investment Strategy Podcast

13/07/2016

FAÇONNER L'AVENIR DE L'IMPACT INVESTING

Impact Investing

07/07/2016

BREXIT : QUELLES PERSPECTIVES POUR LES BANQUES ?

Point de vue des marchés

04/07/2016

L’ARGENT POURRAIT-IL TOMBER DU CIEL ?

Bulletin de stratégie d'investissement

01/06/2016

MARCHÉS ÉMERGENTS : STABILISATION DU PÉTROLE ET DU DOLLAR BIENVENUE

Stratégie de placement trimestrielle

04/05/2016

PERSPECTIVES D’INVESTISSEMENT

PERSPECTIVES D’INVESTISSEMENT

Investment Strategy Podcast

29/04/2016

JAPON : LES CERISIERS FLEURISSENT, LES SALAIRES NATIONAUX FLÉTRISSENT

Stratégie de placement trimestrielle

28/04/2016

EUROPE : LA REPRISE DEVRAIT MAINTENIR SA CADENCE

Stratégie de placement trimestrielle

25/04/2016

ÉTATS-UNIS : l'ECONOMIE RESTE SOLIDE

Stratégie de placement trimestrielle

21/04/2016

LE CYCLE DE CREDIT TOUCHE A SA FIN

Perspectives d'investissement

19/04/2016

LES CRAINTES D’UN BREXIT SONT LÉGITIMES (PARTIE II)

Investment Strategy Bulletin

18/04/2016

L'ECONOMIE MONDIALE A ENCORE DES RESSOURCES

Stratégie de placement trimestrielle

15/04/2016

LES CRAINTES D’UN BREXIT SONT LÉGITIMES (PARTIE I)

Bulletin de stratégie d'investissement Avril 2016

13/04/2016

ALLOCATION D'ACTIFS

Stratégie de placement trimestrielle

12/04/2016

UNE CRISE DE CONFIANCE MONDIALE ?

Philanthropie

05/04/2016

SWISS FINTECH INNOVATION

Association

31/03/2016

AMERIQUE LATINE - QUELLES OPPORTUNITES ?

Investment strategy

23/03/2016

VERS DES TAUX NEGATIFS

Investment strategy

24/02/2016

L'ART DE MESURER L'IMPACT

Stratégie de placement

28/01/2016

PERSPECTIVES D’INVESTISSEMENT DU 1er TRIMESTRE 2016

PERSPECTIVES D’INVESTISSEMENT DU 1er TRIMESTRE 2016

Investment Strategy Podcast

19/01/2016

LE PIRE EST-IL PASSÉ POUR LA RUSSIE ?

Strategy Bulletin

03/11/2015

PERSPECTIVES D’INVESTISSEMENT DU 4ÈME TRIMESTRE 2015

Investment Strategy Podcast

14/10/2015

INVESTIR SUR L’« ÂGE D’OR »

Strategy Bulletin

28/09/2015

Coup de projecteur sur la Fed

Strategy Bulletin

30/07/2015

Grèce : après le référendum

Strategy Bulletin

06/07/2015

La hausse du pétrole est plafonnée

Strategy Bulletin

28/05/2015

Opportunities and risks in global markets

Opportunities and risks in global markets

Investment Strategy Podcast

19/05/2015

Notre foire aux questions sur la Grèce

Bulletin d'investissement

17/02/2015

Economic outlook 2015

Bullletin de stratégie

17/12/2014

BAISSE DU PÉTROLE: BONNE OU MAUVAISE NOUVELLE ?

Bulletin de stratégie

01/12/2014

DES TEMPS DIFFICILES POUR L'AMÉRIQUE DU SUD

Bulletin de stratégie

03/11/2014

LA BNS DOIT-ELLE EMBOÎTER LE PAS À LA BCE ?

Bulletin de stratégie

20/06/2014

LA STRATÉGIE DE DÉSENDETTEMENT DE LA CHINE

Bulletin de stratégie

24/04/2014

ABÉNOMIE : LE PLUS DUR RESTE À VENIR

Bulletin de stratégie

18/03/2014

QUELLES SONT LES OPTIONS DE LA BCE

Bulletin de stratégie

13/02/2014

BAISSE DE LA CROISSANCE CHINOISE ET OPPORTUNITÉS

Bulletin de stratégie

21/01/2014