Allianz Global Investors Insights - June 2017

Why We’re Constructive on Oil Not many investors have been bullish on the price of oil recently, but Allianz Global Investors has had a constructive view of the industry for more than a year. Here are five reasons why we think the price of oil will turn around – and why investors should consider positioning themselves to take advantage of the opportunity. Global demand for oil is reassuringly stable Although the International Energy Agency lowered its predictions for oil-demand growth in 2017 from 1.4 million barrels per day to 1.3 million, global demand has remained reassuringly stable. At the same time, oil inventories have been decreasing and global economic growth is buoyant. Taken together, these factors should underpin a steady demand for oil despite higher prices. Multiple factors will constrain the oil supply On 25 May, members and non-members of the Organization of the Petroleum Exporting Countries (OPEC) agreed to continue reducing production in an attempt to drain the oversupply of oil, boost prices and shore up some of the more fragile petro-states. With geopolitical tensions already elevated, we could see a further premium on prices if markets become more nervous about the outlook for these oil-dependent nations. New discoveries are dwindling With new oil fields becoming increasingly hard to find over the past few decades, the global economy is now essentially relying on a few old and ageing mega-fields. Reserve-replacement ratios are near their lowest level in 70 years, and this figure is unlikely to pick up if there is no major investment increase.Unfortunately, there has been a cutback in oil discoveries that we believe will filter through by 2019 and will noticeably reduce supply. The market could be looking at another oil-price spike not too far in the future. The US shale industry has problems In recent years, new technologies and drilling techniques contributed to a US shale-oil boom that significantly boosted supply and helped drive down oil prices. When OPEC nations restricted their oil production late last year, largely in an effort to combat low prices, US shale producers seized the opportunity to ramp up their output and exports. This further altered the balance of supply and demand in the global oil market. Shale oil is a clearly profitable source of production for US energy companies, but it is important to note that the US is still a net importer of oil and other petroleum products. Moreover, the US shale-oil industry as a whole is grappling with some significant issues, including negative cash flows, growing constraints on personnel and equipment, and unsustainably low costs that are beginning to increase rapidly. Domestic production is falling in a booming Asia China’s domestic oil production is in decline and additional reductions are expected. At the same time, China’s energy demands are growing along with its population size. This suggests that China will increasingly continue to rely on the global markets to add to its supply. In addition, India, Indonesia and other Asian nations are also seeing production declines even as regional economic growth is expected to move significantly higher overall. This should lead to increasing demand from the global markets. Today’s low prices make oil an attractive opportunity for investors On 15 May, Saudi Arabia and Russia announced an agreement to extend production cuts through March 2018 in an attempt to get surplus inventories under control – a move that was mirrored on 25 May by OPEC and non-OPEC members. Eventually, of course, these OPEC restrictions will be unwound once inventories are reduced to normal levels, which should result in a more natural supply/demand balance. Moreover, geopolitical tensions alongside a lack of exploration and new project sanctions appear set to reduce supply globally. This combination of factors should lead to historically low global spare capacity, which could lay the foundations for an oil-price spike. We also expect to see excitement in the marketplace surrounding the impending initial public offering of Saudi Aramco, which is expected to be valued as one of the top 10 companies in the world. This could have a halo effect on the markets. In recent months, the oil price has been depressed because the market did not see the quick inventory declines it was looking for; as a result, speculative long positions contracted. We believe this happened at least in part because of a lack of good data about global inventories, which meant the markets focused only on US numbers. Either way, inventories would normally be building during this period due to seasonality, and instead they are falling. We believe this contributes to an attractive longer-term opportunity for investors. Drill deeper For more insights, read "5 Reasons to Expect Higher Oil Prices", available on www.allianzgi.sg