Here are our notes on the two main causes for the downturn in oil.

1.) Cyclical Low (Reflected in the price) – Supply & Demand

  • Currently global economic growth is slowing down and is at the low of its cycle. Significant is China’s reduction in its demand for commodities and energy.
  • Middle East oil producers are not reducing capacity.  Western countries have lifted sanctions on Iran where the earliest it may begin production again is early 2016.
  • Iran has 10% of the global crude oil reserves and 18% of the natural gas reserves. Before the sanctions, Iran’s daily oil production peaked nearly 300 million barrels.
  • UN Climate Summit in Paris finalises a historic agreement aimed to reduce emissions of oil and other fuels reducing demand in the future.
  • The US ends its 40-year ban on oil exports which will increase the global supply of crude oil in the short term and increase the downward pressure on international oil prices.

2.) External Factors (Not Reflected in the price)

  • Technology in batteries and electric vehicles is making headway.
  • China has developed a high performance super capacitor electrode material that has excellent energy storage characteristics.
  • This “super cell” can be used in electric vehicles and a 7 second charge translates to 35km.

 

Fig 1: 10 year oil price action (Source: Stockcharts.com)

Fig 1: 10 year oil price action (Source: Stockcharts.com)

Fig 2: 1-year oil price action (Source: Stockcharts.com)

Fig 2: 1-year oil price action (Source: Stockcharts.com)

 

The Effect From The Downturn In Oil Prices

  • International oil prices have fallen to a 7 year low
  • Revenues of Middle Eastern Governments have fallen leading to the spending of their fiscal reserves. To deal with their budgets, these countries have also had to issue bonds in an emergency.
  • To save their economy, Middle East sovereign funds have taken the lead to redeem funds from the asset management companies.
    • The world’s 4th largest sovereign fund has US $673.9 billion in assets at Saudi Arabian Monetary Agency SAMA (The Central Bank of the Kingdom of Saudi Arabia)
    • In 2015 there has been withdrawals of about US $70 billion leading to a slump in foreign reserves at SAMA.

 

Conclusion

The strategy for the model portfolios does not involve exposing to the Middle East sector at this stage. We will continue to monitor the sector and its developments for you.

Best,
Michael

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