3 Reasons for Higher Oil Prices

April 2017
  

After six months of oil prices fluctuating between $43 and $54, what can catalyze a sustainable move higher?

  

WTI crude oil averaged $52-53 per barrel between December 2016 to February 2017, before tumbling into the upper $40s through most of March as investors grew increasingly concerned about a larger supply glut from higher US crude inventories and production. Currently, crude oil stands above the psychological threshold of $50 per barrel as markets scout for signals of lower supply. While oil prices may temporarily fluctuate based on heightened geopolitical tensions, the fundamental environment may continue to improve for oil prices (and the overall energy sector) as markets rebalance. Jennison Associates’ Global Natural Resources Equity portfolio manager, Jay Saunders, provides the following reasons for higher oil prices near term:

  1. Significant inventory drawdowns coming soon
    While US inventories are currently high, sharp drawdowns may be on the horizon given higher demand as refinery maintenance season recently ended. Additionally, global inventories have been falling in more pivotal areas as shifts in futures market pricing reduce storage incentives. This has led to oil coming out of storage from less recognizable areas such as offshore or independent storage locations in Rotterdam, South Africa, and Singapore.

  2. High OPEC compliance with extension potential
    Unlike during previous deals, this time there has been surprisingly high compliance across the board with Saudis leading by example. While OPEC has not signaled what they plan to do regarding production cuts at their May 25th meeting, it’s likely the Saudis will push for an extension given their need for sustainably higher crude prices to aid in the success of the IPO of Saudi Aramco, the world’s largest oil company, planned for in 2018.

  3. US production likely to fall short of lofty expectations
    US exploration & production companies (E&Ps) started ramping up production quickly after oil prices surpassed $50/barrel. The speed of the recent ramp-up was largely a result of equipment and services providers who had been forced to slash prices after the 2014 oil price collapse to stay afloat, but are now in the process of increasing equipment & services prices as they regain pricing power, resulting in higher costs and expenses for E&P companies looking to increase production. E&Ps are now faced with either paying up for equipment & services or risk not hitting their production targets for the year. As a result, it’s likely production growth targets announced by E&Ps for this year are overly aggressive and unlikely to be achieved as quickly as anticipated. Yet, reasonable US production growth will be needed to meet growing global demand given the market dominance and cost efficiencies of US shale drilling.

Ways to Play

While oil prices have recently been range-bound absent a credible reason to break out substantially in either direction, material evidence of tapered production or sharp inventory drawdowns could serve as long-awaited price triggers for an upward move in oil prices. The resultant environment makes select areas across the energy value chain attractive, as it could spur capital investment in the upstream segment and raise demand for energy infrastructure in the midstream segment. PGIM Investments offers the following funds that may help investors seeking to capitalize on favorable energy fundamentals:

Prudential Jennison MLP Fund
Invests primarily in Master Limited Partnerships (MLPs) and MLP-related investments

 

Prudential Jennison Natural Resources Fund
Invests in companies that own, explore, mine, process, and develop natural resources commodities


Learn more about Investing in Energy.



The Organization of Petroleum Exporting Countries (OPEC) is a union of oil-producing countries that regulates the amount of oil each country produces. West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark for oil pricing.

The comments, opinions and estimates contained herein are based on or derived from publicly available information from sources that Jennison Associates believes to be reliable. We do not guarantee the accuracy of such sources or information. Investing involves risks. Some investments have more risk than others. The investment return and principal value will fluctuate and the investment, when sold, may be worth more or less than the original cost and it is possible to lose money. Past performance is not a guarantee of future results.

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Jennison Associates is a registered investment advisor and Prudential Financial company. © 2017 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, the Prudential logo, and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.

 

0304288-00001-00 Ed. 04/2017