Crude oil suffered a major sell-off in November, the steepest decline the commodity has seen in over a decade. As 2019 gets started, how should institutional investors handle their exposure to the commodity?
Some pension plans may already be at capacity in terms of their asset mix for oil-exposed investments like corporate bonds and domestic equities, says Dec Mullarkey, managing director of investment strategy at Sun Life Investment Management. But even so, the energy sector is very attractively priced given expectations for the year to come.
“There is a lot of bad news already built in, so oil from an institutional perspective is actually a pretty good investment right now,” says Mullarkey.
Part of the steep fall is an increase in the overall production from the United States, Russia and some Middle Eastern members of the Organization of Petroleum Exporting Countries, says Mullarkey. In addition, sanctions the U.S. government placed on Iranian oil pushed production from Russia and Saudi Arabia even higher to fill the gap. The market saw a sudden glut of about 1.5 million extra barrels when the U.S. softened its stance and gave key consumers like China and India a pass on using Iran’s crude, he adds.
“That has since been addressed. OPEC met in early December and said, ‘We’re going to scale back’ and Saudi and Russia were all on board with that,” says Mullarkey. “But that still takes a while to work itself into prices.”
As well, U.S. President Donald Trump’s fickleness on dealing with oil will be an issue to watch since his real motivation to changing his mind at the last minute is somewhat unclear, says Mullarkey, suggesting the president’s thinking was influenced by the worry that if he didn’t acquiesce, oil prices would be noticeably higher, trickling down to the price of gas and into the average voter’s mind. Nevertheless, things are more or less squared away and demand remains solid, boosting the outlook on crude for the coming year, he says.
Even with the cautious attitude on oil, the drop was still a surprise, noted Mark Lacey, head of commodities at Schroders Investment Management Ltd, in a recent blog. However, Schroders’ overall view of the sector is positive, he added.
As indicated by Lacey’s list of Schroders’ house views on fossil fuels, any outlook requires investors to make a number of assumptions. For example, he believes the International Energy Agency and the OPEC are currently underestimating demand for the year, noting China and India’s needs may surprise to the upside. In addition, he said North American oil wouldn’t be enough to flood the market.