What Middle East Tensions Mean for Oil Prices & Equity Portfolios
20 August 2014 - 9:00AM
ETFDB
With turmoil in the Middle East dominating headlines, many
investors are wondering what the recent and growing unrest in the
region means for oil prices and for equity portfolios.
In my new Market Perspectives piece, “Oil’s Precarious Balance,”
I provide my take: While I certainly can’t predict the outcome of
events in the Middle East, oil prices are likely to remain toward
the upper end of their recent range for the foreseeable future
given current supply and demand dynamics. Even without a sustained
spike in oil prices, there’s a strong case for sticking with energy
stocks simply based on valuations.
First, here’s a quick look at my expectations for oil supply and
demand. Currently, oil prices remain elevated because global demand
has continued to climb, despite slower growth in China, and supply
overall has been unexpectedly constrained by both geology and
geopolitical unrest. Looking forward, oil supply is likely to
remain constrained and oil demand is likely to continue to
grow.
Oil supply: There’s a good chance that future oil supply may be
tighter than expected. Currently, oil prices remain in a somewhat
precarious balance, supported by a long-term rise in North American
production, but at the mercy of falling production and exports in
much of the Middle East and Africa.
However, U.S. production growth is likely to decelerate in the
coming years, placing more of a burden on OPEC, where rising
geopolitical risks put supply increases in jeopardy. In other
words, at a time when stable North American production will be
decelerating, there will be an increasing call on production from
the most unstable parts of the world, particularly Iraq. This in no
way suggests that the world is somehow “running out of oil,” but it
does mean that given the low likelihood of a clear resolution in
the Middle East, supply is likely to disappoint.
Oil demand: Meanwhile, oil demand is likely to continue to rise.
Over the long run, economic activities and population growth are
the key drivers of oil demand. While oil demand in developed
markets is likely to remain soft on the back of improving
efficiency and slower secular growth, increased demand in emerging
markets — driven by urbanization and increasing car ownership —
will probably offset this trend.
As for what this means for investors, even without the prospect
for higher oil prices, I would maintain an overweight exposure to
energy stocks simply based on valuations. Despite outperforming
year-to-date, energy sector valuations still have room to grow, as
measured by looking at the S&P Global 1200 Energy index.
Multiples are still at a discount to their 10-year average and fund
positioning is low, as I point out in my new Market Perspectives
paper. In addition, I continue to see good free cash flow and
several recent investment projects are beginning to bear fruit.
In particular, I see good opportunities in certain integrated
companies and exploration and production companies where there is
resource growth.
Source: Market Perspectives piece “Oil’s Precarious Balance”
Russ Koesterich, CFA, is the Chief Investment Strategist for
BlackRock and iShares Chief Global Investment Strategist. He is a
regular contributor to The Blog.
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