CityWire - Oil volatility: where are the bright spots for GCC investors

The global oil market deficit is said to have reached its peak, and oil prices have remained range-bound since early June, transitioning from a relief rally to cyclical tightening.

However, as oil is a spot physical asset and not an anticipatory financial asset like equities, it must clear the large inventory overhang currently estimated at over 1 billion barrels in excess stocks accumulated year-to-date.

‘Oil seems to have bottomed out and global crude inventories are likely to decline in the coming months as demand slowly rises,’ said Bal Krishen, chairman of Century Financial

Analysts suggest that the momentum is easing due to weaker demand progress on the back of sluggish global jet fuel growth and challenges to global economic normalization, as well as higher supply growth from OPEC and US oil production.

‘Now that we have transitioned from the relief rally to the cyclical tightening stage of the global oil market recovery, the inventory normalization process has been driving a flattening in the Brent forward curve, but spot upside should be capped by excess stocks with the rolling of inventory hedges weighing on deferred contracts, effectively reducing the incentive to drill for unnecessary new barrels,’ explained Ehsan Khoman, head of MENA research and strategy at MUFG Bank. 

He expects the combination of tepid demand growth and clearance of the large inventory overhang to induce an upside cap in oil prices for the rest of the year, forecasting Brent at US$36/b at the end of Q3, closing Q4 at US$46/b.

The stabilization of oil prices will help prevent further income erosion for GCC governments.

‘Major GCC nations like Saudi Arabia and UAE have a war chest worth hundreds of billions of dollars and their bonds should be interesting for investors. Saudi Sukuks maturing in 2049 have a YTM of 3.82% while Abu Dhabi bonds of 2049 have a 2.74% yield. The precarious finances of Oman mean its 2025 is trading at nearly 5% yield,’ Krishen said.

Allocation

According to Krishen, many fund managers have high allocations in clean energy to properly de-risk from the business environment. Allocations to the oil-related sector tend to be more tactical in nature. 

When oil prices plummeted below zero, Century Financial undertook tactical decisions. Viewing the scenario as unrealistic, they advised their clients to increase their equity allocation in blue-chip oil companies.

‘Our view was that once the crisis passes, oil demand will be back to normal in 18-24 months and the companies should naturally benefit. Our bets paid off and we have reduced the allocation given the run up in asset prices,’ Krishen said.  

His team also avoided oil-based ETFs due to the structure of the futures curve at that point of time. The firm prefers to have an equal allocation between risk assets and bonds. In equities, it provides allocation to battered sectors such as airlines, hospitality and emerging markets.

Fixed income

Having recently screened for bonds with yields higher than 5% and an investment grade rating from the three major rating agencies, Century Financial has in fact found several corporate bonds with favorable yields.

This includes Deutsche Bank bonds with YTM of 8.74%, Marathon Oil with 6.37%, General Motors with 6.25% and Energy Transfer LP with 7.57%.

For investors who prefer sovereigns and can stomach some risk Krishen also suggested Egyptian bonds with 8%+ yield that could also be worth it.

Alternatives and equities

Low interest rates and high levels of liquidity will aid in global economic recovery. The GCC is expected to benefit from this liquidity as some will find its way to the real estate and financial market assets here, Kirshen saud, 

He believes that Dubai real estate sector is now ‘ripe for the picking’ although the index suffered over 40% decline last year. Dubai’s hospitality sector is also attractive from a two-year perspective with the prospect of a vaccine by the end of this year.

‘Abu Dhabi banks due to the sectoral consolidation and Saudi retailing on account of social reforms, seem to be good choices for investment.

‘The strong liquidity in the system means financial market assets could have a sharp rally. Real economy recovery is likely to be more slow-paced and could gather full momentum only in the beginning of next year. Basically, we expect consumer confidence to recover only after the arrival of a coronavirus vaccine,’ he concluded. 

Source : CityWire