Emerging markets still deserve attention
We believe corporate revenue and earnings growth is likely to continue in most key emerging market sectors in 2018 and provide ongoing investment potential.
The arrests in Saudi Arabia of business leaders and members of the royal household as part of a corruption purge comprise only one of the unpredictable factors facing the oil market in 2018. The growth in global oil supply was constrained in 2017 by output quotas from the Organization of Petroleum Exporting Countries (OPEC). And thanks to a decision reached at its latest meeting, those quotas will stay in place through the coming year. But other market uncertainties may not be resolved so soon.
Worldwide oil inventories have continued to fall during 2017, with demand better than originally forecast and supply growth limited by lower oil prices and OPEC’s output quotas.
OPEC members plus Russia and nine other producers originally agreed in November 2016 to quotas that would reduce output by 1.2 million barrels per day (bpd) to a new target of 32.5 million bpd. The goal was to address a supply glut that was pressuring oil prices. OPEC in May 2017 extended the quota agreement to March 2018.
At its meeting on Nov. 30, OPEC ministers again decided to extend the agreement. OPEC members continue to seek to stabilize the oil market, reduce global inventory levels and attempt to spur an increase in oil prices that will boost their revenue. The quotas represent one reason oil prices are up more than $10 per barrel since the 2016 introduction of the agreement — indicating it has been successful thus far.
Many had expected this extension after Saudi Arabia and Russia declared support for extending the global deal for another nine months.1 Saudi Arabia’s Crown Prince Mohammad bin Salman had said he was in favor of such an extension, echoing similar comments made by Russian President Vladimir Putin.
Expectations for the latest extension had supported prices in the run up to the OPEC meeting, with additional price support from ongoing strong oil demand. We expect that global oil demand will continue to grow at an annual rate of 1.2–1.4 million bpd in 2018 (significantly above the recent historical average of 1.0 million bpd), on top of the current total demand of about 98 million bpd. Rising political tensions, including in oil-producing countries, also have supported prices and added to their volatility.
It’s impossible to accurately predict oil prices in a market driven by factors ranging from the internal politics of oil-producing and consuming countries to the weather. But we believe that a direction for prices can be established by examining fundamental supply and demand factors — which oil prices have strayed from in the past.
We believe that most production growth in the world will continue to come from the U.S. in 2018, but we do not believe this growth will happen at the pace predicted by many on Wall Street. The investments required to significantly grow production are difficult at current price levels. As the market begins to recognize this fact and oil inventories continue to fall, we believe oil prices will rise.
In addition to fundamentals that we think point to rising oil prices, the market in 2018 again must contend with uncertainties that could affect global oil supply. If they are not navigated correctly, any of these factors could spur a short term spike in prices. We think those uncertainties include:
In what many believe is a move to consolidate royal power, Saudi authorities in early November detained key members of the royal household — which includes government and business leaders. The action followed a decree from King Salman bin Abdulaziz Al-Saud that created an anti-corruption committee chaired by his son and heir, Crown Prince Mohammed bin Salman. Those detained included Prince Alwaleed bin Talal, the billionaire owner of international investment firm Kingdom Holding; and Ibrahim al-Assaf, a former finance minister and board member of Saudi Aramco, the world’s largest oil company. As part of the apparent purge, Prince Mutib bin Abdullah was relieved of his duty as head of Saudi Arabia’s national guard, which serves as an internal security force. This force now directly serves the crown prince and we think there is little potential for a successful insurrection against him.
The action initially has had little impact on the oil market, but raises potential stability concerns for Saudi Arabia. According to OPEC data, Saudi Arabia has about 22% of the world’s proven petroleum reserves and is the largest exporter of petroleum.2
In addition, Saudi Arabia announced in early 2016 that it planned to do an initial public offering (IPO) of a portion of Saudi Aramco. In October, Chief Executive Amin Nasser said the plan was on track for a listing in the second half of 2018. Saudi Aramco has said it plans to list the shares on the Saudi domestic exchange and one or more exchanges outside the country.3 However, no location or exchange outside the country has been announced.
We anticipate the market may get a better idea — although not complete disclosure — of Saudi Arabia’s total oil reserves after an IPO, which in the past has been considered a state secret. But a public stock listing will require more transparency than is available today about Saudi Aramco’s business, including reserves, production costs and timelines, and other information.
A potentially more immediate concern about Saudi Arabia is its traditionally rocky relationship with Iran, another significant oil producer. On Nov. 4, Shiite rebels in Yemen fired a missile at Riyadh, Saudi Arabia’s capital. The missile was shot down by Saudi defense forces. It is believed that the missile used was produced by Iran, which would mark a significant escalation in hostility between Saudi Arabia and Iran. The Saudis have hinted at retribution aimed at Iran, although no action has yet been taken.
News outlets reported in early November that a militant group known as the Niger Delta Avengers would end its ceasefire with the Nigerian government. The group has battled with the government in the past over issues related to the Niger Delta region – Nigeria’s main oil-producing area that includes its coastline on the Atlantic Ocean. The group announced it is not satisfied with the progress of peace talks or the response to its demands related to the multi-state region of the country. It threatened to resume attacks on oil facilities in the Niger Delta, which it had halted after agreeing to the ceasefire.
The potential for damage to Nigeria’s oil industry adds to uncertainty about the oil supply picture in 2018. Nigeria, which is an OPEC member, said in mid-November that its oil output had reached 2.7 million bpd.⁴ But that supply could be reduced if the Niger Delta Avengers carry out their threatened attacks on the industry.
Venezuela has faced a growing economic crisis for several years and now is dealing with severe shortages of food and medicine, high crime rates and increasingly authoritarian leadership. Venezuela’s late president, Hugo Chavez, claimed the country was plagued by economic mismanagement and corruption. He nationalized hundreds of private and foreign-owned businesses, including major oil projects of U.S. companies. Current President Nicolas Maduro has continued many of those criticisms and this year took steps to increase his power as president, taking some authority from the elected national assembly.
Venezuela — an OPEC member — had averaged about 2.4 million bpd in oil output for many years, but production fell to 2.1 million bpd in August 2017 with the prospect of further declines.² The last data show that oil revenues account for about 95% of Venezuela’s export earnings and the oil and gas sectors combined make up about 25% of gross domestic product.⁵ The economic crisis in the country raises questions about those indicators and the oil industry in the future – especially following an announcement on Nov. 14 by S&P Global Ratings that the country was in “selective default” after missing payments on two of its bond issues.
In addition to any impact from the wild-card issues, the world oil market in 2018 is expected to be heavily influenced by the supply fluctuation from U.S. shale, which can come online more quickly than other production methods. Oil supply from U.S. shale still meets only about 5% of total worldwide demand but, more importantly, it is likely to represent about 75% of supply growth in the world in the next year. We expect some cyclical upward pressure on service costs for U.S. oil producers that could help sustain the current oil price rally.
Our outlook overall has not changed, although the growth in oil demand from emerging markets surprised many in the third quarter this year. In general, we expect steady global economic growth to continue in 2018, further contributing to the growth in oil demand.
Despite an abundance of supply sources for oil, we think the industry is in the early stages of a cyclical recovery as oil fundamentals improve. Margins and returns also are likely to improve from their cycle lows in 2016. We believe the main drivers of this growth will be higher volume, higher capacity utilization and continued improvement in cost efficiency. We also believe that rising oil prices will be a tailwind to revenue growth for energy companies in 2018.
In summary, the key things we will be watching as we move into 2018 are OPEC policy, U.S. production levels, service cost inflation and inventory levels.
1 OPEC’s head says Saudi, Russia statements ‘clear fog’ before November 30 meeting, Reuters, Oct. 27, 2017
2 Facts and figures, Organization of Petroleum Exporting Countries (opec.gov)
3 Saudi Aramco’s IPO, the world’s largest ever, is ‘on track’ for 2018, CEO Amin Nasser says, CNBC, Oct. 23, 2017
4 Nigerian Crude Oil Production Hits 2.7 Million Barrels, Nigerian National Petroleum Corp., Nov. 15, 2017
5 Venezuela Crude Oil Production, Trading Economics (tradingeconomics.com)
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