Crude Oil Prices Dodge the Emerging Markets Bullet

 | Sep 06, 2018 | 1:11 PM EDT
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Long crude oil versus short emerging market equities has proved a money-making strategy over the past six months and this trend is likely to continue as the sell-off in the region exacerbates while oil prices slowly remain steady, if not up. Crude oil prices, measured by the United States Oil Fund LP ETF (USO)  , have outperformed the iShares MSCI Emerging Markets ETF (EMM) by almost 30 percentage points since the beginning of the year.
 
The downturn in emerging markets has hit primarily weak OPEC producers like Venezuela, Ecuador and Nigeria, where crude oil prices need to be above $80 a barrel to balance their budgets. Even growing oil and gas provinces such as Argentina's prolific Vaca Muerta basin and Mexico's emerging energy sector are facing challenges, both economically and politically. Pressure in these markets has been exacerbated by tough trade and sanction policies enacted by the Trump Administration, ongoing U.S.-China trade tensions and the current trade agreement negotiations with Mexico and Canada.
 
Despite this sell-off in emerging markets, sanctions and trade battles, our bellwether champion in the sector continues to be Russia's national oil company, Rosneft, whose stock is up over 40% in local currency benefiting from record earnings driven by production and more than a 10% slide in the ruble.
 
West Texas Intermediate crude oil prices have also outperformed the S&P 500 by 1,000 basis points since the beginning of the year, primarily driven by geopolitical headlines. Oil has kept a floor at $65/barrel over the last three months, which is a healthy level for most U.S.-based shale producers. We anticipate crude oil prices to trade in the $65-$75 range until the end of the year in absence of major supply disruptions. Brent pricing has been more benign for U.S. Gulf Coast producers like W&T Offshore (WTI) and Talos Energy (TALO)  , which price its crude to this benchmark instead of West Texas Intermediate prices.
 
We believe the market has priced at least 500,000 barrels a day of Iranian oil production out of the market and the expectations are to the upside in case sanctions have a more dramatic effect in the market ahead of the Nov. 4 deadline. The specter of China not respecting U.S. sanctions allowing Iran to sell some of its crude in market will put a ceiling on how much prices can rally from here. We anticipate Iran finding a way to dodge sanctions and bring their crude to market.
 
As for dealings with China, ExxonMobil (XOM) is moving ahead this week on a proposed multibillion-dollar petrochemical project and a gas import terminal in Guangdong province in southern China, contrasting with U.S.-China trade tensions that may escalate this week. XOM signed cooperation framework agreements with the Guangdong provincial government following a preliminary deal in November. The chemical complex is expected to start in 2023 subject to a final investment decision.
 
At the end, we expect U.S. allies and foes to keep trade flowing despite ill-fated policies emanating from the White House as the balance of power rapidly adjusts around the world, also in favor of emerging markets.
 

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