Has Global Oil Price Peaked?


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.

Revisiting e-commerce platforms


An investing quote goes: When the last bullish investor turns bearish, it’s only a matter of time before the market bottoms out. Masayoshi Son, Softbank’s chief executive officer and a staunch supporter of Chinese e-commerce stocks, recently reduced the company’s holdings of Alibaba stocks from 23.7% to 14.6% – could Son be that last bullish investor? All jokes aside, Softbank does have to raise cash to pay off some of its loans, and now could be a good time to review how investors should approach the businesses of e-commerce platforms.

Increasingly fierce competition

Investors who have looked closely at Alibaba’s results over the past few fiscal quarters must have noticed what management attributed to having impacted its earnings: Intensifying competition. Though of course, most investors know full well that the tightening regulatory oversight should also be among the factors that have had a bearing on Alibaba’s results. But its management, with Alibaba being at the forefront of regulatory actions, clearly knows better than to speak in public about anything related to the government. Indeed, the domestic e-commerce space has seen competition flare up significantly over the past few years. Pinduoduo, for example, now boasts active users whose number rivals that of Alibaba, while its gross merchandise value jumped 16-fold in the previous four years, up from just 3% to 30% of the gross merchandise value of Alibaba’s China commerce at the end of last year. Given that each active user spends around CNY 2800 annually on the Pinduoduo platform, just a fraction of the CNY 8800 annual spending of Alibaba’s active users, there should be plenty of scope for Pinduoduo to grow. While the company has repeatedly emphasised in the past that the platform focuses on agricultural products, as long as it garners enough users, it should be able to expand into other product categories with relative ease.

Apart from Pinduoduo, some short video platforms are also accelerating their livestream shopping businesses. Despite the Chinese government’s ongoing attempts to tighten regulatory control since late last year over the livestream shopping industry, Kuaishou still managed to grow its gross merchandise value by 47% in the March quarter compared with the same period the previous year. And in the last 12 months until the end of the March quarter, its gross merchandise value reached CNY 730 billion, close to 9% of what Alibaba made. While there’s no official data on TikTok, given that it’s still a private company, surely TikTok would boast more livestream transactions than Kuaishou. Clearly, competition among e-commerce platforms looks set to get increasingly fierce.

Earnings outlook

There are many one-time charges in Alibaba’s financial statements that if one is to get a good grasp of its earnings trends, one will have to look not only at its annual report, but also keep track of its core earnings per share in each fiscal quarter with all one-time charges removed from the analysis. Alibaba’s year-on-year core earnings per share started to drop since fiscal third quarter last year, and continued into fiscal second quarter this year without showing signs of narrowing in the scale of the decline. Given a slowdown in China’s economy induced by Covid-related lockdowns beginning in March, it remains unclear where the bottom of Alibaba’s earnings lies. As such, the pace at which Alibaba’s year-on-year earnings grow in fiscal second quarter becomes even more important – even though a low base last year would mean that the company should be able to achieve a year-on-year increase in earnings relatively easily, investors will need to be mindful of the residual effect of Covid-related lockdowns on Alibaba. And despite a plethora of investment initiatives, there’s no denying that, thus far, Alibaba generates a large part of its profits from the traditional retail e-commerce business in the domestic market. Unless any of its businesses make a breakthrough, we think it’s unlikely that Alibaba will see its earnings grow at the same scale as before.

The valuation of Alibaba

Alibaba has seen a decline in its year-on-year earnings since fiscal third quarter last year. Assuming a full-year drop in its core earnings in fiscal third quarter this year, and taking that into account in the calculation of its price-to-earnings ratio (P/E ratio), it will place Alibaba’s current P/E ratio at around 13.3x. Unless its earnings fall further on a year-on-year basis, we believe this P/E ratio looks quite fair.

Last but not least, given Alibaba’s plan to make Hong Kong its primary listing destination, capital from mainland China will likely stream across the border into Alibaba at the end of the year, supporting its stock price. 

Conclusion

To summarise our analysis of Alibaba above, as the domestic e-commerce industry grows ever more competitive, we don’t see any new growth area for the time being unless there is a breakthrough in Alibaba’s new businesses. But if its earnings stabilises on a year-on-year basis in the coming fiscal quarter, there should be limited room for the stock price to retreat further from its P/E valuation of 13x. Meanwhile, it should help that Alibaba is seeking a primary listing in Hong Kong, whose capital inflow from China will likely support its share price.


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.