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Is Oil A Long Term Buy?

Oil prices were so low at the beginning of the year, that some made the argument that bottles of water were more expensive. But with OPEC pledging to curb production, a tightening of the market could happen before the year ends. Investors are more focused than ever on these potential actions, the potential supply imbalances and ultimately whether the trade is to the long or short side.

Long Thesis

There are many reasons to be long oil as a long-term trade. Current issues threatening the industry are rooted in oversupply; an oversupply that is the result of continuously advancing discovery and extraction technology.

Extracting these new discoveries has increased production costs, but despite costs of production often being higher than $50 per barrel, it has ‘not crushed’ the oil industry say analysts at Pioneer Investments.

Energy companies are taking advantage of low financing and new technology to innovate and lower the costs of production. Low interest rates have enabled firms to recapitalize and restructure newly competitive businesses, according to the analysts.

And even though production has suffered, it has not fallen sharply. Prices will probably start to stabilize soon, Pioneer goes on to say.

These sentiments are echoed by Richard Turnill, Global Chief Investment Strategist of BlackRock.

‘We believe the oil price outlook has brightened, due to an unexpected OPEC plan to cut production and a surprisingly big drop in U.S. oil stockpiles.’

Short Thesis

However, not everyone feels the global oil glut will end.

It will ‘likely continue,’ complicating Fed policy and promoting cooperation among producers, say analysts at hedge fund R-Squared Macro.

Oil supply will continue to outpace demand for the fourth consecutive year, driving stockpile accumulation into 2017, projects the International Energy Agency.

And as this happens, this will likely suppress U.S. inflation, challenging the Fed’s previous rate hike projections. Other side effects of the oil market swings are contributing to emerging market asset volatility and encouraging a less ambitious normalization cycle, say analysts.

The outlook for commodities is not exceptionally rosy, says Corey Hoffstein, Co-Founder & Chief Investment Officer at Newfound Research.

The last time there were so many oil bulls was in mid-2014, after which we saw W&T Offshore Inc. crash 58% a few short months later, warns Brent Millar, Fortuity Risk Analytics.

A report from the Commitment of Traders indicates that large speculators have the biggest oil position since 2014. Back then, crude oil futures were trading at nearly double their current price — around the $100-per-barrel.

Short Thesis

However, not everyone feels the global oil glut will end.

It will ‘likely continue,’ complicating Fed policy and promoting cooperation among producers, say analysts at hedge fund R-Squared Macro.

Oil supply will continue to outpace demand for the fourth consecutive year, driving stockpile accumulation into 2017, projects the International Energy Agency.

And as this happens, this will likely suppress U.S. inflation, challenging the Fed’s previous rate hike projections. Other side effects of the oil market swings are contributing to emerging market asset volatility and encouraging a less ambitious normalization cycle, say analysts.

The outlook for commodities is not exceptionally rosy, says Corey Hoffstein, Co-Founder & Chief Investment Officer at Newfound Research.

The last time there were so many oil bulls was in mid-2014, after which we saw W&T Offshore Inc. crash 58% a few short months later, warns Brent Millar, Fortuity Risk Analytics.

A report from the Commitment of Traders indicates that large speculators have the biggest oil position since 2014. Back then, crude oil futures were trading at nearly double their current price — around the $100-per-barrel.

‘This signals some exuberance among large speculators, possibly hoping for an OPEC deal,’ says Chris Prybal, quantitative analyst at Schaeffer’s Investment Research.

Bottomline

The long thesis can be summarized as market reactions tend to overshoot the true fundamental correction, and supply/demand imbalances eventually normalize. While this is true in most cases, with oil there are other risk factors, the biggest of which being consumer behavior.

Today, decreases in global demand for oil are typically due to economic factors such as slowing emerging market growth. However, there are also real market dynamics in play that may drastically decrease oil demand irrespective of global growth trends.

By 2025, oil-consuming cars could be in permanent decline with the growing presence of more alternatives such as ride-sharing and more affordable electric and hybrid alternatives.like an increase in affordable electric cars.

A weaker demand picture paired with high debt levels will further exacerbate the current oversupply dynamics. Historically these imbalances could be artificially manipulated by OPEC, but if the fundamentals of the demand side truly change than oil becomes a far more elastic commodity and the long trade potentially painful.
Source: Forbes

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