Advertisement

Oil was my 2016 “trade of the lustrum” – but should you keep holding on?

A couple of years ago, Dominic Frisby picked oil as the best five-year trade you could make. Now it’s in the doldrums, he revisits his trade to ask: what next?

181128-oil
The US produces more oil than both Saudi Arabia and Russia

Today we take a look at oil.

It may be the most important fuel in the world, but, as far as the price is concerned, gravity has taken hold.

It has, this past month or so, fallen off a cliff, as they say. And it continues to fall.

Today we consider they whys, the wherefores and the what nexts.

What's behind the oil price slump?

From just shy of $87 a barrel at the beginning of October, Brent touched $58 on Friday, meaning it lost about a third of its value. It is currently sitting at $61.

Advertisement - Article continues below

West Texas Intermediate (WTIC) did something similar, falling from $77 to $50 a barrel. It's currently sitting at $51.

One always likes to know why these kind of moves take place I often think the reason gets tacked on afterwards to make sense of the narrative. Nevertheless, the generally accepted reason for this current move boils down to perceived excess supply.

Advertisement
Advertisement - Article continues below

A month ago there were fears that US sanctions on Iranian oil exports would mean a loss of something like a million barrels a day (bpd) to global supply. $100 oil was coming, they said.

Then the US issued sanction waivers for eight countries importing Iranian crude. US production hit record highs the US now produces more oil than both Saudi Arabia and Russia. And, with stockmarkets, and thus economies, generally perceived to be weak, the forecast was that demand is going to tail off as well. In short, global markets are amply supplied.

Advertisement - Article continues below

US president Donald Trump, meanwhile, has taken the credit for the move, which is most unlike him, proclaiming: "So great that oil prices are falling (thank you President T). Add that, which is like a big Tax Cut, to our other good Economic news."

To be fair, he had been having a go at oil cartel Opec over high oil prices for many months, and the sanction waiver does appear to have been a major trigger for the change in direction of the oil price. Lower prices were what he was gunning for.

He is now urging Saudi Arabia not to cut its production, but it seems Saudi Arabia will, nevertheless, in an effort to stabilise prices, cut its own output by around 500,000 bpd, and urge other Opec nations to do the same.

How far will oil fall this time?

Oil seems to experience these violent sell-offs every few years. I still remember 2008 like it was yesterday. Oil had been in a bull market for nearly ten years that took it to almost $150 a barrel. Within six months, it gave back five years of gains and touched $36.

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

2014 saw another epic sell-off, now known as the Great Oil Bust. Brent had traded for around three and a half years, mostly in the $100 to $125 range. These kind of levels looked like the new normal.

Then, not unlike now, president Barack Obama lifted US sanctions against Iran, US shale production surged and there was lower-than-expected global demand. Oil went from $115 to $45, bounced and eventually hit $27 a barrel in early 2016, an extraordinarily cheap number.

Here are 15 years of Brent, so you can see the action.

MM181128-oil

In early 2016, I called buying oil "the trade of the lustrum" (a lustrum is a five-year period. It's an almost criminally underused word).

Oil was $33 and our advice was to buy, hold and forget. Prices would go a lot higher, and they did.

Our main vehicle for buying oil was not the usual suspects BP (LSE: BP) and Shell (LSE: RDSB), but BHP Billiton (LSE: BLT). Even though BHP is known for mining, oil is its biggest product and it tracks the oil price well better, bizarrely, than BP, Shell or the iShares oil and gas exploration and production ETF, (LSE: SPOG).

Advertisement - Article continues below

BHP has actually held up very well in the face of this sell-off, currently sitting above 1,500p (we recommended it at 700p). BP, Shell and SPOG our other suggestions are now in downtrends.

So the question now is, how far is the oil price going to fall?

Advertisement
Advertisement - Article continues below

I rather suspect this sell-off is going to be more like those of 2004, 2006 or 2012, rather than the monsters that were 2008 and 2014-15. That is just a feeling, by the way, a hunch it's not based on any detailed analysis of oil supply-and-demand statistics.

But you do get a feel for the way a particular market trades the more you watch the price.

I'm projecting Brent to make a low in the $45-$55 range. Thus I'm not sure this sell-off is quite done yet, although a bounce is probable.

If Brent goes to $45 I think there is a real opportunity there and I'll almost certainly be looking to load up. Shell, at this point, is the one I really have my eye on, as well as BP. Dividends and all that. If they carry on declining and BHP holds, that is where the greater value might be.

Short-term traders might even be eying BHP as a short, given the fact it has held up where others have fallen. Not for me that one, but I can see the argument.

As for the trade of the lustrum. This was a long-term trade with a five-year horizon. We are two and half years into it. Given oil went from $33 to over $80 there was a good argument to be taking profits up there.

But if you sell now, will you be sure to buy back at lower prices? Will we even see lower prices?

Questions, questions, questions. Buy, hold, forget was the strategy. So we stick with it.

Advertisement
Advertisement

Recommended

What escalating tension between Iran and the US means for oil prices
Global Economy

What escalating tension between Iran and the US means for oil prices

The tension between the US and Iran is unlikely to mean all-out war in the Middle East. But markets may be getting a little too complacent about its e…
6 Jan 2020
Rising output will keep a lid on the oil price
Oil

Rising output will keep a lid on the oil price

Oil exporters’ cartel Opec gave further encouragement to the bulls this month after agreeing to new production curbs.
20 Dec 2019
Brace yourself for pricier oil
Oil

Brace yourself for pricier oil

Global growth, and hence demand for oil, could surprise on the upside next year, leading to a bounce in the oil price.
29 Nov 2019
Why has the oil market taken the Saudi attack so calmly?
Economy

Why has the oil market taken the Saudi attack so calmly?

After an initial spike in the oil price, the market seems to have shrugged off the attack on Saudi Arabia’s oil infrastructure. John Stepek asks if it…
23 Sep 2019

Most Popular

BP has slashed its dividend – and markets love it
Income investing

BP has slashed its dividend – and markets love it

BP has bowed to the inevitable and cut its dividend in half – and its share price promptly rose. John Stepek explains what it means for shareholders …
4 Aug 2020
Listed companies are dying out, and that could have serious consequences
Stockmarkets

Listed companies are dying out, and that could have serious consequences

Private equity is taking over from public stockmarkets as the biggest provider of capital to companies. That’s bad for investors and bad for society a…
3 Aug 2020
Gold hits the big $2,000 level – are Aim miners about to play catch up?
Gold

Gold hits the big $2,000 level – are Aim miners about to play catch up?

With the price of gold shooting through $2,000 an ounce, the yellow metal looks unstoppable. Things are so bullish, even Aim-listed junior gold miners…
5 Aug 2020