“This is a frightening statistic. More people vote in ‘American Idol’ than in any US election.” – Rush Limbaugh, American radio talk show host
“When luck plays a part in determining the consequences of your actions, you don’t want to study success to learn what strategy was used but rather study strategy to see whether it consistently led to success.” – The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing by Michael J. Mauboussin
“Sometimes it is the people no one can imagine anything of who do the things no one can imagine.” – Alan Turing
Oil Market Misery
Since late September, when oil prices hit four year highs, Brent and WTI prices have slumped by more than 20 and 23 per cent, respectively. With economic sanctions fully re-imposed on Iran starting 5 November, the price action of oil market makes one wonder if it is yet another case of buying the rumour and selling news.
The drawdown in oil prices coming at a time when Chinese oil imports have surged to record levels makes it all the more glaring.
The sharp drop in oil prices over the last six weeks has attributed to a number of factors, including:
- The growing conviction that the Trump Administration’s will take a soft-touch approach in policing adherence of the economic sanctions on Iran;
- Rising US oil production;
- Expected growth in production from OPEC member states after the easing of production quotas;
- Global economic growth expectations for next year being revised downwards, in turn implying weaker oil demand growth next year; and
- Higher than anticipated levels of crude inventory builds in the US.
On Monday, when the US administration announced granting waivers to eight of the largest importers of Iranian oil including China, India and Turkey, it was seen as confirmation that US’s enforcement of sanctions on Iran will be lukewarm at best. We do not agree with this view and see no reason for the Trump Administration to take anything except the most hard line approach towards Iran.
The waivers granted by the US have been on the cards ever since the Trump Administration first announced it would re-impose sanctions on Iran back in May. They are a means to avoid disruption in the oil market and to give importers ample time to shift away from Iranian oil. The waivers have little to no impact on Iranian oil exports expectations for 2019 and beyond. Iranian oil exports are expected to drop from a peak of 2.5 million barrels per day in 2018 to less than 1 million barrels per day during the grace period afforded to the eight importers and drop off sharply once the waivers lapse.
We expect the Trump Administration to tighten the noose around the Iranian economy in 2019. We see no political or economic incentive for President Trump to act otherwise. Trump’s Middle Eastern allies – Saudi Arabia and Israel – are passionately in support of the sanctions and with mid-terms elections now out of the way Mr Trump is unlikely to agitate over a moderate rise in domestic gas prices at the cost of appearing to go easy on Iran.
Moreover, Mr Trump’s band of trade warriors and security hawks, with one eye on the on-going trade negotiations with China, are likely to be partial to higher oil prices and unlikely to want to see the Administration come across as being soft. Higher oil prices put a squeeze on the Chinese economy and increase its need for US dollars – factors that are likely to give the US an upper hand in trade related negotiations with China.
As it relates to rising US production capacity, nothing has changed since oil prices peaked in September to alleviate capacity constraints and infrastructure bottlenecks that would allow for an uninterrupted rise in US production. If anything, the recent drop in prices is bound to have a negative impact on future production growth.
We also think that worries about rising output from OPEC and Russia are misplaced. Although OPEC member states and Russia agreed in June to raise production by a combined 1 million barrels per day from May levels in order to offset expected losses from Iran and Venezuela, the Saudis and Russians are reportedly already contemplating production cuts for 2019 in response to the reason drop in prices. Our view is that oil exporting nations have little to no incentive to release their stronghold over the oil market.
High oil prices, a strong US dollar, rising interest rates and a slowing China certainly raise cause for concern for global economic prospects in 2019. Despite the concerns, OPEC still expects world oil demand to grow by 1.36 million barrels per day in 2019. Moreover, Chinese demand should continue to increase with at least two major refineries scheduled to start operations during the first half of 2019.
We consider the recent sell-off in oil to be largely sentiment driven and an unwinding of exceedingly bullish positioning by speculative accounts. Total net long exposure has declined by around 40 per cent in the last six weeks – representing almost 400 million barrels of crude.
Given that oil market supply-demand dynamics point to a probable supply deficit in 2019 and waivers for Iranian sanctions set to expire in six months, we expect oil prices to consolidate and move higher from current levels in the coming weeks and months – potentially even making a new cyclical high in the process.
Amazon Ups Its Advertising Game
Just a quick update on Amazon and another step the company has taken to increase its share of the advertising pie.
Amazon is shipping its first-ever printed holiday toy catalogue, titled “A Holiday of Play”, to millions of customers starting this month. Toys featured in the catalogue come with a QR code, allowing readers to instantly scan and shop for the products. Readers can also scan the product images in the catalogue with their Amazon App to get more information.
This is quite an interesting development in our view. We have a hunch that Amazon’s efforts have been heavily subsidised by advertising dollars from brands eager to feature their products and logos in the catalogue.
If Amazon’s efforts to blur the boundaries between offline and online prove successful in increasing consumer spending on its website, we can certainly envision a scenario where Amazon, the combination of the website and catalogues, becomes the go to destination for consumer brand advertising. Which half of the advertising pie Amazon gets its share from is likely to have far reaching implications for both digital incumbents (Google and Facebook) and traditional media.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.