Oil prices now go beyond the supply/demand equation

Interview with MR Raghu, Head of Research, Markaz by Peter Duke, Sales Director, Fidelity Worldwide Investment

Peter Duke: Good morning welcome to the Fund Forum Middle East. My name is Peter Duke from Fidelity Worldwide Investment. I am delighted to be joined today by Mr. MR Raghu, Head of Research, at Markaz. Raghu Welcome!

Raghu: Thank you

Peter Duke: Your special subject today is oil so of course we kickoff with the basic question around demand and supply and how you see those dynamics in your market at the moment

Raghu: Sure! You know at a very broad level, any commodity is always impacted by demand and supply. Price is always a function of demand and supply and this works very well for oil as well. In the past when we have demand slackening, the supply gets adjusted and therefore the prices defended. Now that model has broken down and we have a double whammy now if I may call it. So we have a weak demand and we have an oversupply , so this is killing the price, obviously. Now the question to ask is “why is supply not getting adjusted to a weak demand to defend the price?” ok that’s where I feel the politicscomes in to play and that’s why I said there is a shift in the way we have to think about the oil market in the current context of the simple “demand – supply –price” equation.

Peter Duke: Raghu you said that argument about politics must be the role of Saudi Arabia is key here. How do see that and how do you judge that policies on internationally working, do you think that it will stabilize away.

Raghu: Yes it was very surprising the way I understand how Saudi has acted at this time around, because traditionally OPEC which is “Saudi Arabia” always had this defend price strategy in place. But they have observed that unconventional oil has come to the market in a big way and the traditional price driven response may actually backfire on them after some time. So they have decided to play the gamble and the gamble is,  “don’t defend the price but defend your market share” which means keep producing rather produce more you know to get more market share and they know the consequence. The consequence will be a lower price and we all see that today. But the thing is there is an inflexion point to this gamble.They want to play this till they get the high cost producers out of the scene and then go back and play their original equation of defending the price. Now, the thing is “who is going to blink first?”, that is the question now. So the way we understand unconventional producers,  it’s a very hazy picture because there is a technology angle to it, there is a price angle to it and the player profile is different, the conventional oil is controlled by national oil companies for example, backed by huge sovereigns, unconventional oil is controlled by small players who are mostly in the just bond market,  such a completely different dynamics. So we don’t know the jury is still not out and we hope the Saudi gamble pays off and the oil market comes back to at least $70-80 as they wanted to be in the medium term. But right now we are in the scene, so we don’t know the climax.

Peter Duke: Well that might be the answer. But have you been surprised by the resilience of Shale produces in the US

Raghu: Absolutely, not only the resilience but the continuous downward estimate of the cost of production, because I remember Goldman Sachs were predicting the cost of unconventional oil about $80 to start with about two years back. But today they are talking about $60 and they are estimating it to go down. So as the cost of production goes down then you know both sides may not blink for a long time.So that is big event to watch. So it’s not happening, you defend your market share and people just go out of the system, they are just not going out of the system actually.

Peter Duke: We have new people coming in to the system like Iran what’s your view

Raghu:Iran is not a big thing as people make it out to be. But definitely in about three four years they will even contribute to the oversupply situation. But not only Iran, we have to talk about Iraq, we have to talk about Libyaall hotspots where we thought supply could be constrainted, are never constrainted . So they are actually adding to the glut of the supply and then demand side is getting bad and therefore we have a double whammy effect on the price.

Peter Duke: if you see this oil crises at these level may be increasing in the medium term. What is the impact in terms of the GCC economies, the stresses that may come out?

Raghu: I feel that the impact is more negative for MENA economies rather GCC Economies. Why because GCC Economies are sitting on huge reserves and they have the fire power to withstand this low oil price environment for a considerable period of time. All this tension about Saudi’s reserves dwindling very fast, it’s over blown in my view. Saudi’s definitely have amassed huge reserves that can stand them today in good stead compared to where they were in 1998 for example when oil prices were very low. But it will hurt MENA economies much more than GCC economies obviously because the breakeven oil price for MENA economies are much higher compared to GCC economies. For exampleIran requires an oil price of $135, Saudi Arabia requires oil price of $100, Kuwait requires an oil price of $50. So the comfort zone is definitely much better in the GCC compared to MENA economies. So it’s the MENA economies that will start putting pressure to the extent they are in OPEC cartel to really stop this defending market share game and at least give us some price that we can breathe.

Peter Duke: One final question that I wanted to put on the spot in terms of oil prices at the end of this year what you think is the reasonable number

Raghu: That’s an easy question to answer because we are already close to end of the year, so I am fine to take a call on that! You know oil prices are now range bound between a band of $40 to $60 and I think that’s going to be there for some time. The $100 oil price era is simply gone. But we are not definitely in to the $20 oil scare as well. So $40 to $60 is a world comfort price but whether that is the “Comfort price” for GCC I don’t know.

Peter Duke:Raghu thank you very much for your insights. You heard this for Fund Forum Middle East. Thank you.

Raghu: Thank you, it’s a pleasure talking to you.

Drop in Oil Price Is Structural Not Cyclical Says Fereidun Fesharaki

This article was originally published on the website of CFA Institute

At the 2015 CFA Institute Middle East Investment Conference, energy expert Fereidun Fesharaki presented a grim picture of the global energy markets. Against a backdrop of volatile energy prices, the founder and chairman of FGE discussed the changing energy landscape and argued that the recent major drop in the oil price is structural rather than cyclical, adding that he expects a rebound in the oil price only in 2017/18. He believes this structural shift is good news for the global economy but bad news for oil exporting countries.

The Structural vs. Cyclical Debate

Fesharaki’s main argument was that oil price change is structural because of the way the United States has transformed as an energy producer during recent years with very few people noticing. He explained that while the United States was producing between 4.5 and 5 million barrels per day (mbd) 2 to 3 years ago, today it is producing an additional 4.5 mbd, which is more than Kuwait at 3 mbd. In the liquefied natural gas (LNG) space, he said the United States is now among the top three exporters, while just three years ago it was importing LNG. And the same goes for propane, an important fuel in the energy system, he added. Qatar, Abu Dhabi, and Kuwait were the top three producers of propane about three years ago. Currently, US production of propane is larger than the three countries combined. Fesharaki argued that with the increasing US dominance in the energy sector, it is clear why the price adjustment is structural rather than cyclical.

Estimating the Likely Oil Price

Assuming no new dramatic geopolitical events, Fesharaki stated that he expects a price rebound in 2017/18 and that it will not be anywhere close to $100 per barrel but may be more like $70. For 2015, he expects the price of oil to be $5 more than it is now. He believes the oil price will be volatile with a $20–$30 swing in prices.

Fesharaki said that a steady and stable $100 per barrel during the last few years has made people assume that this is the norm, which has led to extraordinary investments in energy. Meanwhile, he continued, while supply steadily increased, thanks to the United States, Iraq, and Canada, demand continues to be muted. He added that Asia’s demand is 50% lower today than three years ago, as some of the Asian countries (such as India and Indonesia) made the most of low oil prices and removed subsidies that enabled a straight pass through, which created a demand rebound.  Fesharaki said that the Middle East used to experience one of the highest demand growths, thanks to a young population, low prices (subsidies), and lots of cash. Now he believes that things have changed for the worse in the region and that most of the GCC countries are on track to pull back subsidies (except Saudi Arabia).

The Saudi Strategy

The announcement that Saudi Arabia will not lower production has ignited the current oil price collapse, Fesharaki said. He thinks this is not a political decision but an economic one that has political consequences. Saudi Arabia knows the importance of being a credible political powerhouse rather than an oil powerhouse, he added. Fesharaki believes that Iran provided them with an important lesson: After sanctions, Iran lost about 60% of oil exports and became politically irrelevant. So, he contended, defending market share is more important than defending price in order to be politically relevant. Before changing course, he said, the Saudis will now await new evidence, which may come by the end of 2015 or early 2016.

Final Thoughts

Fesharaki argued that at $40 per barrel (which is $15 lower than the current level), nearly 70% of oil producers in the United States will stop production. He believes we might see this price point somewhere in the second quarter, due to contraction in demand by about 2 mbd. At this price point, he concluded, investors of expensive oil (read shale oil) will reconsider.

The Alpha and Beta of Commodities Investing

This article was originally published on the website of CFA Institute

At this year’s Middle East Investment Conference, Russell Read, CFA, had a tough task. The chief investment officer and deputy chief executive of the Gulf Investment Corporation (GIC) was called on to explain the complex world of commodities investing and its role in generating portfolio returns. But as the man who helped introduce the first commodity-based mutual find in 1997, attendees couldn’t have asked for a more seasoned professional to explain the role of these often impenetrable instruments.

Commodities may be tough to understand, but they are one of the oldest traded financial instruments. The Dojima Rice Exchange dates to 1730. The Chicago Mercantile Exchange Board was founded in 1858. Most students of finance are in fact reasonably aware of the two main tools for trading commodities: futures contracts, which are exchange traded with minimal counterparty risk, and forward contracts, which are traded over the counter and involve counterparty risk specific to each instrument.

Commodity trading is used for physical hedging, financial hedging, repositioning, and speculating by specialty investors, such as hedge funds. What trips up many professionals is the leveraged nature of the trading, which requires marked-to-market margin levels. This scares away many institutional investors because trading futures and forwards contracts is mostly tactical. Read emphasized that successful speculators need special skills that are not commonly found in stock and bond portfolio managers.

Read put forward the argument that commodity futures and forwards contracts cannot be considered an asset class because they are not natural diversifiers to stocks and bonds for institutional investors. In addition, he contended, the primary focus on hedging and repositioning does not lend itself to either market (beta) returns or the potential for above-market results (alpha). Still, he acknowledged that if commodities are held in an unleveraged and diversified way, they can aspire to be a separate asset class.

Should investors gain exposure to commodities via indices? S&P GSCI and Dow Jones AIG are the major reference indices. The main reasons to invest in them, Read said, are diversification, long-term return potential, and inflation protection. However, inflation protection from commodities is mostly limited to energy exposure. The introduction of energy commodities into a typical portfolio split 60/40 between stocks and bonds improves returns while reducing volatility, thanks to low correlations. However, index exposure to commodities may not appeal to many investors because it is an amalgam of rolling futures contracts and thus tends to deliver beta rather than alpha generation.

So how can investors position themselves for alpha in the commodities space? One way is to buy or sell physical and financial commodities where supply and demand  are “out of balance” due to various reasons, Read said. This is what most active managers and hedge funds do. Of course, traditional managers are often bound by relative returns to benchmarks. They cannot short securities, utilize derivatives, or own leveraged exposures. In contrast, alpha managers are driven by absolute returns. Still, the alpha business is getting highly competitive thanks to less liquid markets, more complex instruments, and innovators exploiting new opportunities for returns.

On balance, though, commodity strategies do have a major and multidimensional role to play in a diversified portfolio — especially for investors in the MENA region, where management of commodity risk remains less developed. Furthermore, the strong relationship between energy prices and MENA stock price appreciation (and economic growth generally) makes commodities a great additional source of returns and an important hedging and diversification tool.

Gold prices set to hit $2,500/oz as buying season kicks in

Beginning with Eid, gold buying to heat up with Indian wedding season, Diwali, Christmas and Chinese New Year

The price of gold, the ‘safe haven’ commodity, is expected to continue its new rally in the forthcoming months as the gold buying season kicked in on Tuesday with the first day of Eid – a traditionally strong period of gold sale in the Middle East.
Closing at $1,791 per ounce on Monday, the first day of Eid saw gold price jumping more than 2 per cent, or $38, to $1,827on Tuesday, followed by another rise on Wdnesday, and was trading at $1,837/oz at 12 noon UAE time. Spot gold held steady on Thursday with little change at $1,824.39 an ounce.

This rise is despite a massive increase in margin requirements to trade gold announced last week by the CME Group Inc., the parent company of the main metals and energy exchanges in the US. It raised the amount of money needed to trade gold contracts by 27 per cent to $9,450 per100-ounce contract.

Experts believe that this latest rally will defy the hike in margin requirements and propel gold prices beyond the$2,000-mark in the coming months. In fact, some experts are calling for double of that level.

According to Steen Jakobsen, Chief Economist from Saxo Bank, gold still has a long run ahead. “Looking at how precious metals will react to a new QE (quantitative easing), the answer is simple. I think we will see $3,000 if not $4,000 for gold, and other metals should follow suit.”

Gold’s latest upward journey has already begun with Eid, and gold buffs maintain that it will continue until the Chinese New Year with significant gold buying happening during Diwali, Christmas, and the Indian wedding season.

However, downward risks remain, say experts. “As with the dollar, if this is the ‘end game’ then the spike will be followed by risk-aversion which could overall curtail the highs. At all times, one has to realise this is close to the end of the trend, and for every $100gold rises, the risk increases disproportionately as there is more and more speculative hangover involved,” added Jakobsen.

M.R. Raghu, Senior Vice-President-Research at Kuwait Financial Centre (Markaz), believes that some moderation is likely. “Gold has performed 33 per cent for the year out of which 13 per cent was post the US downgrade (August 5). Obviously, the run up is too fast and hence some moderation is bound to happen at this level,” he told Emirates 24/7.

“For investors that entered the party early on, it may be a good idea to cash out partly at these levels. From here, the price may correct, say 5 to 10 per cent, before resuming another go. Hence, I would not advise investors a total exit from gold since the macro picture is negative, which is kind of positive for gold at least for some time to come. It may find it difficult to hit $2,000 [per ounce], but once it does, you can see more buying coming in,” he said.

Advocates of gold affirm that gold remains the world’s go-to currency. Commodities analysts at Standard Bank said recently that after touching record levels, gold came off its highs a few days back, as risk aversion subsided. “Equities across the globe rebounded as investors shrugged off the pessimism of the past few days and moved into riskier assets, amid growing concern that the bullion rally was overdone and hopes of further Fed monetary stimulus. However, this was short-lived, as risk aversion was soon apparent, as Asian markets opened. Moody’s downgrade of Japan’s sovereign credit rating reignited concerns over the developed world’s fiscal problems, sending Asian equities into the red, to the benefit of safe-haven precious metals,” said a recent report released by the bank.

“[A] drop in prices has attracted an element of bargain hunting, which should provide support across the precious metals complex in today’s trade. However, with European stocks currently trading up it appears as if risk appetite is not completely absent, which could limit the upside for precious metals,” it added.
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Gold price to reach $1700/oz

Published Wednesday, June 29, 2011 in Emirates 24|7. click here to read

With gold prices hovering around the $1500-per-ounce-mark, experts believe that a surge in prices in the next six months is likely, with prices reckoned to increase by about 15 per cent to reach $1700/oz by the end of the year.

Despite the fact that the price of the yellow metal has gone up by just 5.5 per cent since the beginning of this year, M.R. Raghu, Senior Vice-President-Research at Kuwait Financial Centre (Markaz), believes that “gold will have another good year in 2011.”

“In my assessment, it is likely to end at $1700 per ounce levels, implying a 20 per cent increase for 2011. It did about 30 per cent for 2010,” he told Emirates 24|7.

With a lacklustre economic recovery in the US and concerns over uncertainty in the European debt markets giving support, gold prices are likely to break previous records, say analysts. The precious metal has immensely gained in popularity as a safe haven investment, and is expected to continue its upward trajectory.

Experts at Standard Bank too are believers in the gold story, and see prices moving up. “We believe gold will continue to push higher in 2011. Our core view on gold is driven not only by our observations in the physical market but also by continued growth in global liquidity, driven not so much by the Fed anymore, but increasingly by government borrowing,” said Walter de Wet, a commodity analyst at the bank.

Experts maintain that the performance of the yellow metal is less volatile as compared to other commodities, giving it more scope to appreciate.

“Unlike silver or oil, gold has a risk-controlled performance so far with low volatility as it has a wider audience (retail, institutional, hedge funds and government treasury). As articulated before, gold will continue its march so long as US economic recovery is hazy, Europe is in doldrums and the inflation monster in Asia is uncontained,” explains Ragu.

In its first quarter report of 2011, The World Gold Council said that gold demand grew 11 per cent compared with the first quarter of 2010, as the average gold price for the quarter rose 25 per cent year-on-year. It’s an as-expected quarter, said the council.