Has Global Oil Price Peaked?

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Many people, especially car owners, breathed a sigh of relief as the price of Brent crude oil has plummeted by over 30% since the middle of 2022, but is it safe to say the oil prices have peaked? The analysis of different data suggests otherwise.

Let’s talk about the supply first.

Above all, the United States has less room to hold oil prices down by reducing its Strategic Petroleum Reserve (SPR). In the past six months, the United States has released 140 million barrels of crude oil. The SPR has depleted to just under 400 million barrels, which is the lowest level in the past 40 years. According to the weekly report of the U.S. Energy Information Administration, President Biden’s plan to tame energy costs by releasing SPR will be completed in December 2022. The U.S. Department of Energy in October also formulated a plan to replenish the SPR when the price of crude oil is at or below $67-$72 per barrel. These suggest that there is less and less room to bring down oil prices by selling SPR.

Secondly, the capital expenditure of oil companies has reduced significantly in the past two years, which means future supply may be affected. The annual reports of major global oil companies Chevron and Occidental Petroleum show that their capital expenditures have been well below the depreciation rate since 2020. The short-term benefit of this trend is that oil companies can generate a lot of free cash flow for debt reduction and dividend payments. But the disadvantage is that without sufficient investment, it will be difficult to maintain the future production capacity at the current level, particularly when the United States has increased the production of shale gas and shale oil significantly in the past 10 years. The nature of shale oil fields is different from that of traditional oil fields. Without continuous investment, the annual decline in shale oil production capacity will be faster than traditional oil. Unless oil companies significantly increase capital investment in the future, supply reduction is very likely to happen.

Some may ask, “Didn’t Russia’s oil exports drop due to the sanctions? If Russia resumes production after the war, will that offset the potential supply reduction from oil companies?” Surprisingly, according to the oil tanker tracking data, Russia’s oil exports have increased from the pre-war level in the past six months. The main export destinations are non-G7 countries and non-European regions, with China and India being the primary purchasers. This suggests that even if the Russian-Ukrainian war is over, Russia still has limited room to increase production in the future.

Another point worth considering is the exchange rate of the U.S. dollar. The weakening of the U.S. dollar has a positive impact on oil demand because oil prices will fall in non-U.S. dollar regions. For the time being, leading indicators show that the risk of a U.S.  recession is increasing. In addition, the Federal Reserve is expected to slow the pace of interest rate hikes, which will ease the dollar’s appreciation. A weakening USD will drive oil demand and hence oil prices.

The last factor that may weigh on the supply demand equation is the potential demand from China. China is the second-largest oil consumer in the world. In 2022, China’s economic growth slowed down due to COVID restrictions and the real estate crackdown, which made its oil demand milder. But now, demand from China may pick up again since the government has decided to terminate COVID zero and reopen.  As such, we expect there will be an increase in oil demand in the foreseeable future.

All the factors we have discussed may contribute to the return of higher oil prices, so are there any risks of a decline in prices? At present, the main risk lies in whether the global economy will slide into recession in the coming year. However, comparing that with the above 5 supporting factors, the chance of oil prices rising should be greater than the risk of falling.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

Beat the market: Which investment strategies actually outperformed?

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Something that fund managers tend to do often is highlighting their investment styles. Investment strategies can be divided roughly into two categories: macro forecasting and stock selection, with the latter often categorised further into value investing, momentum investing, and quality investing. On top of these, there are funds that put their emphasis on small-cap stocks.

Value investors target primarily stocks with low price-to-earnings ratios, price-to-book ratios, and high dividend yields; and momentum investors tend to chase after companies with ample liquidity and whose share prices have been on the rise in the past 6 to 12 months. Meanwhile, quality investors focus their attention largely on companies with higher returns on equity, lower volatility in earnings growth, and lower debt ratios.

The question, therefore, lies in which one of these stock selection strategies are more resilient to the test of time, and are able to deliver higher returns to long-term investors. Let’s begin by looking at US stocks, and make our way to Chinese equities.

In fact, MSCI’s full-fledged Factor Indexes can help us find the answer. Looking back on the 15 years before the end of May this year, the global stock markets fell twice into bear and prolonged bull market, respectively, while the Chinese stock market swung more frequently between the bear and bull territory; the performance of indexes that had been tracking these markets, then, could to some extent reflect how each of the various investment styles fared under different market conditions.

What we found is that, the quality strategy posted the best performance in the US, with the MSCI USA Quality Index outperforming the broader MSCI USA Index by 2.2% in annual return rates. The momentum strategy, on the other hand, surpassed the main index by a mere 0.4% in return rates. Being the worst performer, the value index underperformed the benchmark by an annual rate of 2.4%. Also underperforming the benchmark was the MSCI USA Small Cap Index, which fell short by 0.8% on average annually over the past 15 years.

What about Chinese equities, then? The MSCI China All Shares Quality Index charted a 7.1% annual rate of return in the past 12 and a half years as of May’s end, outperforming the MSCI China All Shares Index by 4.1%, a margin that surpassed the 2.2% that the MSCI USA Quality Index posted in excess of the MSCI USA Index.

If we were to look just at the MSCI China A Quality Index, we would find that its annual rate of return outperformed the broader MSCI China A Index by a significant 5.3% in the past 13 and a half years as of May’s end.

The MSCI China All Shares Momentum Index, in contrast, only eked out an outperformance of 0.1% against the MSCI China All Shares Index in the past 13.5 years as of May’s end, with most of the former’s returns contributed by gains from 2017 and 2020. In 2020, particularly, the momentum index outstripped the benchmark by a whopping 47%, which led to its return rate being much more volatile than that of the MSCI China All Shares Quality Index.

The performance of the MSCI China Value Index and the MSCI China Small Cap Index resembled largely that of their US equivalents, lagging the main China index by 1% and 2% respectively in the past 15 years, which we think is due to the fact that a lot of the small cap stocks are, at the same time, also value stocks.

Clearly, opting for quality stocks makes for a superb strategy to beating the market whether or not you are investing in US or Chinese stocks. The momentum investment style proved to produce returns inferior to that of the quality strategy in the US market; meanwhile, it appeared overly volatile in the Chinese market. We also think investors targeting value and small cap stocks should take a cautious approach – unless dividend yields are a top priority, cheap stocks could turn out to be nothing more than a “value trap”.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.