Pledges to reduce production means oil will be best investment bet in 2017

With Donald Trump set to enter the White House later this month and populists on the march across Europe, political risk will loom large in 2017.

Pledges to reduce production means oil will be best investment bet in 2017

Cautious investors may find stability in an unfamiliar place: the oil market.

A deal between Opec members and other producers to limit output next year won’t simply syphon off some of the global glut of crude: if participating nations make the cuts they’ve promised, the effort will also add to a buffer of unused capacity that can be tapped to plug supply disruptions.

“If you’ve got Opec full adherence for the first six months, the market should be relatively insulated from political risk because that cushion is available,” Alan Gelder, a vice president at industry consultant Wood Mackenzie, said.

With the exception of a major disruption in top exporter Saudi Arabia, “anything else should be able to be accommodated.”

Opec members agreed on November 30 to cut output next year by a collective 1.2 million barrels a day, or about 4% of what they pumped last month, in an effort to support prices.

The producer group will probably aim to keep its total supply steady, using its spare capacity to offset any potential disruption from individual members, Mr Gelder said. Eleven non-Opec producers, including Russia, also pledged to reduce production. Brent crude prices have jumped 22% since the end of November.

Global stockpiles of crude oil and fuels, which are near record levels after two years of low prices, will provide an additional cushion against small or short-lived halts in supply.

US crude inventories, at nearly half a billion barrels, are at their highest seasonal level since the government began compiling weekly data in 1982.

Those inventories could be drawn down in the first half of 2017 if Opec and non-Opec producers comply with their promised cuts, and that means political risk could be a bigger factor in the second half of the year, Mr Gelder said.

After three years of volatile oil prices, analysts expect a much quieter year in 2017. Brent crude will trade at an average of $58 in the fourth quarter, according to the median estimate of more than 40 analyst estimates compiled by Bloomberg. The benchmark has climbed 53% this year to trade at $57.11 yesterday, after falling 35% last year and 48% in 2014.

As oil prices stabilise and confidence returns to the patch, there’s been an uptick in oil and gas companies filing to go public. With prized assets in the industry’s promised lands, not all of them make it that far.

In the past month alone, two explorers that were headed for an IPO have, instead, become prey for acquirers: Brigham Resources Midstream agreed to be acquired by Diamondback Energy for a total deal value of $2.43bn, while Gulfport Energy agreed to buy acreage from Vitruvian II Woodford.

Both Brigham, which operates in the lucrative Permian Basin in Texas, and Oklahoma-based Vitruvian were preparing to file to go public as soon as this month, according to sources. Another Permian explorer, Jagged Peak Energy, filed for an IPO in December but is also open to selling itself.

Whether it’s pursuing an IPO or making an acquisition, companies are taking advantage of a resurgence of investor interest in the industry as crude prices level out.

As sentiment improves, there’s been a pile-in effect to get exposure to US assets in particularly oil-rich areas, especially in Texas and New Mexico.

The tail end of this year saw an increase in acquisitions of US oil and gas, services and pipeline companies. Some 185 takeovers worth a total of $147.5bn were announced in the second half of the year, according to data compiled by Bloomberg.

Compare that to the 170 deals for only $36.5bn in the first six months of 2016.

The fourth quarter marked the busiest in a year and a half for IPOs of oil and gas businesses, as well as companies that provide services and pipelines.

Don’t get excited about a boom just yet, though: overall listing activity has been so slow that just three deals raised a total of $1.26bn.

Oil supplies are vulnerable to political risk because production is concentrated in a small number of countries, many of them unstable.

Domestic turmoil and conflict have disrupted supply from Nigeria, Libya and Venezuela in 2016. Major incidents can have a dramatic impact on prices.

Benchmark Brent crude shot from $16 to $40 a barrel — an increase of 150% — during the three months leading up to and coinciding with Iraq’s 1990 invasion of fellow Opec-member Kuwait.

“Even if you have a healthy amount of spare capacity, a sudden supply disruption — or the risk of a sudden supply disruption — is going to move prices,” Richard Mallinson, an analyst at Energy Aspects in London, said.

“Anything that would disrupt half a million barrels a day or more of production, and isn’t clearly very short-lived, is going to get the market’s attention,” he added.

— Bloomberg

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