Cautious Asia

There is not much to say about Asia today, except that market sentiments remained jittery as we head towards the end of the week. Majority of indices in the region was treading in red, although the losses were quite mild.

Offshore Oil Rig
Source: Bloomberg

Fears over the commodity space, especially on oil continued to wash over the risk markets, but has seen some calm today. A little more on the oil sector below.

What was interesting to me was what that was going on in the currency markets. The greenback lost over 1% in the overnight session, dipping to a five-week low of 97.22. However, the dollar made some modest recovery in the Asian session, regaining over 97.50.

Meanwhile, ignoring what is happening to the USD, the renminbi continued to weaken for the fourth straight day. USD/CNY marched higher to over 6.44 from around 6.40 after the SDR inclusion.

On the surface, it may seem that the Chinese are deliberately devaluing the yuan after achieving reserve currency status, which is the idea many analysts have, amid some dollar retreat. However, it should not be a surprise as we head into the all-important December FOMC meeting next week. With an imminent higher interest rate environment, the greenback would move higher.

The short-term positioning of the USD ahead of the FOMC should be taken as market noise. The redback or CNY is just pre-empting the eventual market reaction when the FOMC delivers the rate increase. Clearly, the market is fairly confident that it will happen, with implied probability at a very 78% according to Bloomberg. CME priced it an even higher 87.2%.

One would only wonder what will happen if the Fed decides not to tighten policy. It could be quite disastrous given such an aggressive consensus view.

 

Oil prices recovery in 2016?

I was given the impression that oil prices are set to recover next year, as the Saudis’ plan to use a price war to squeeze out US shale producers and Russian oilers comes to fruition. I was told that the US and Russian producers should be throwing in the towel at the end of 2016 since their losses will be too colossal to carry on. I feel that it’s a bold assertion, and one without deeper research into the sector.

I think that the global oil market is going to stay over-supplied for a while longer, which means oil prices will remain at depressed levels for the near future. I think that the US producers will continue operations, as they are likely to be still making profits, albeit at lower margins, contrary to broadly-held views.

Firstly, the costs of production for US producers have reduced considerably due to efficiency gains. According to Bentek Energy, a market research company in several commodities, including oil, the internal rate of return for US producers was estimated to be show solid profitability even if WTI is at $50, ranging from 6%-16%. While current WTI prices are just below $40, there is a possibility that US producers are still doing ok.

Secondly, the US producers were believed to have hedged their prices when WTI rebounded to near $50 earlier, which means that they have locked in their selling prices for another year or so. This should lengthen their lifespan, and debunk expectations that they will be forced out at end-2016.

To be sure, the renewed oil slump has made life harder for the US producers, but they have also adjusted by focusing on investments with high profit potential in the near future.

Chevron announced that it will focus on investments that will deliver the highest profits in the near-term while postponing those needing a longer timeframe to generate cash. The falling oil rig counts, as reported by Baker Hughes, can be viewed in the context that US producers are focusing on those oil fields that generate more profits.

To summarise, the supply glut is going to persist, without a pick-up in demand as output from OPEC and non-OPEC producers is likely to rise further in the future.

For the US, they might be able to see some relief if the ability to export their oil products increased, although given the current weak global demand, it is difficult to say how much impact more liberalisation in export restrictions will have on US crude shipments. As a corollary, oil prices are expected to remain ‘lower for longer’.

 

*For more timely quips, you may wish to follow me on twitter at https://twitter.com/BernardAw_IG

IGA, may distribute information/research produced by its respective foreign marketing partners within the IG Group of companies pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, IGA accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact IGA at 6390 5118 for matters arising from, or in connection with the information distributed.

This information/research prepared by IGA or IGA Group is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update.

See important Research Disclaimer.