Our central view is that oil, Brent, should trade in a range of $40 to $55 over the medium-term; a slightly wide range. However, we do expect oil price volatility to remain, as we expect demand to pick up from current depressed levels, but that will be offset by the Shale production in the US. Currently, we are at the bottom of this band as the limitation put on OPEC production was only extended for nine months and not the 12 months the market was looking for, and the rig count in the US continues to rise with rumours that most Shale production is profitable above $40 per barrel.
Broadly, as the price of oil increases, the likelihood of production also rises which will keep the upside to the pricing limited. On the downside, which at the moment appears where most of the risk resides, pricing is pressured every time inventories above expectations are announced. This looks to continue for the immediate future until a pickup in demand expected to materialise over the coming months, as the world economy maintains a stable growth rate; which takes away the slack in the supply/demand relationship. This is when the OPEC agreement starts to impact the supply-side of the equation and should benefit pricing and lend support to the upside.
As we have seen over the last year or so the pricing of oil does impact the outlook across Middle Eastern countries’ balance sheets, however, if the $40 - $55 range is maintained investors will tend to look at the strength of individual balance sheets in the region. The stronger the balance sheet the less volatile the country as an investment is likely to be. That is where our Net Foreign Asset calculations aid us and encourage investment in only the strongest of balance sheets, and avoid those countries which may be placed under financial stress during periods of excessive weakness in the oil price.
One trade we like as a hedge on oil price weakness is to be short the Russian ruble (from a conceptual point of view - we haven’t implemented this trade in our portfolios). Russia has devalued its currency in-line with the drop in the oil price since mid-2014 from RUB 34 to the US dollar, to a high of RUB 80 in 2016 when oil reached around $27 per barrel. The ruble currently trades at 59 to the US unit having weakened from 56 on the latest drop in the oil price. Should we see prolonged weakness in oil we would expect the Russian authorities to continue to weaken the ruble to offset that negative pricing so that when their income in US dollars from oil sales is translated to rubles then more rubles are purchased to pay domestic oil production costs.