Yes, though we expect natural resources equities (NREs) to continue to benefit from the rebalancing of supply and demand occurring in oil markets, irrespective of whether the 14-nation cartel follows through on its provisional deal to limit production.
With the explicit aim to “accelerate the ongoing drawdown of the stock overhang and bring the rebalancing forward,” OPEC (the Organization of the Petroleum Exporting Countries) surprised markets last week by announcing an agreement to curb output to 32.5 to 33.0 million barrels per day. To be clear, the agreement is not overly bold. The organization’s production typically falls later in the year, following seasonal demand for air conditioning, and the pre-agreement daily production estimate was only marginally higher than the upper bound of the new target range. Details, including member country quotas, have not been finalized, although some concessions reportedly have been made to Iran, Libya, and Nigeria.
Yet those pessimistic about the deal’s prospects may be missing the forest for the trees. This deal marks a clear shift from OPEC’s previous pump-at-will policy, as initially sketched out in November 2014 to maintain market share. The return to a market-management strategy to support prices is also noteworthy for Saudi Arabia’s softened position toward rival Iran. Saudi Arabia had previously opposed permitting Iran to return to pre-sanction era production levels, highlighting the kingdom’s changing calculus amid heightened domestic pressures.
The agreement is not a sign of a worsening market glut, despite concerns about global oil demand and the return to market of disrupted production. The rebalancing was always going to be uneven and prone to setbacks, but the International Energy Agency, OPEC, and the US Energy Information Administration all forecast growth in global oil demand to be above average this year and next. Taken together with the dramatic reduction in exploration and production investment, the natural decline rate of wells, and expectations for shrinking non-OPEC production, the large overhang of oil inventories weighing on prices was already poised to fall, even if the timing was unclear.
While most natural resources companies’ fundamentals remain challenged, many have benefited greatly from cost deflation, the majority of which is expected to be sustainable on an ongoing basis. Even after the strong performance of NREs this year, which has raised our composite normalized price-earnings metric closer to historical median levels, the asset class is still attractively priced. In this context we continue to view NREs favorably relative to commodity futures, which continue to face difficult headwinds associated with negative roll yields and marginal collateral yields.*
There is a risk that OPEC’s agreement collapses ahead of the cartel’s next meeting on November 30, a fact that would not be helpful to oil prices in the near term. Even if the various OPEC ministers agree to production quotas for member countries, compliance is likely to fall short, as has frequently been the case in years past. But, the broad shift in strategy from the producers of over one-third of the world’s oil—explicitly aimed at hastening the recovery in oil prices—has at the very least reduced downside risks to oil prices, benefiting natural resources equities.
* For more on commodity futures please see Kevin Rosenbaum et al., “Commodity Futures: Still Plenty of Risks,” Cambridge Associates Research Note, March 2016.
Kevin Rosenbaum is an Investment Director on the Cambridge Associates Global Investment Research team.