Goodbye cheap oil
The price of oil has hit $71 a barrel – a three year high – driven mainly by global economic growth and the underinvestment in capacity from years prior.
Oil prices are in a continued uptrend, due to sustained underinvestment in recent years. As a result, the increase in oil prices was almost inevitable, as global growth strengthened.
Today, companies lack the capacity to meet increased demand. While we are seeing an ongoing recovery in energy equipment investments, capacity constraints may continue, due to several factors.
First, the expected wave of shale production is inhibited by logistical constraints. This is best exemplified by the wide spread between Midland and Cushing crude prices – a signal of stress. Despite booming production in the Permian basin, crude oil is not easily delivered to where it is needed.
Spread between Cushing and Midland
Source: Bloomberg, as of 5/22/18. Past performance is no guarantee of future results, which will vary. You cannot invest directly in an index. WTI is the benchmark crude oil (which is priced in Oklahoma), and Midland is the oil priced i nthe Permian Basin (a high crude production area) in West Texas. The reference price for producers in the Permian region in West Texas is generally WTI crude oil priced at Midland (in Texas). Domestically, the trading benchmark for oil price is WTI price of Cushing (Oklahoma).
Second, geopolitical issues further question global supply. The quality of Russian blends is deteriorating, rendering it less usable by many refiners.
While the underlying price of oil has moved higher, the sectors sensitive to oil prices have failed to keep pace. As such, we believe there is scope for both the energy sector and MLPs to catch up, as oil prices hold in the near term.
Comparison of oil vs. MLPs and energy sector
Source: Bloomberg, as of 5/22/18. Indexed at 100 = 7/1/2014. Past performance is no guarantee of future results, which will vary. You cannot invest directly in an index.
With the global economy showing solid growth, we expect demand for oil to continue to trend higher. As such, we are unlikely to see cheap oil again in the near term. Higher oil prices are a key trend to watch for markets, the consumer, and the economy.
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