The immediate future of the world’s worst-performing equity sector hinges on a Nov. 30 meeting of major oil producers, where Russia’s stance on the extension of production cuts could be a dealbreaker.
Even after a recent jump in the oil price helped the MSCI World Energy Index curb some of this year’s losses, it’s still the biggest laggard globally with a retreat of 3.6 percent as investors have fretted about the commodity’s outlook.
Russia has added suspense to Thursday’s meeting by sending mixed signals about its position on the extension of the deal. If the OPEC meeting fails to prolong production curbs past March, brokerage Drexel Hamilton warns that the unwinding of record net long positions in world oil markets could be “quite painful” for exploration and production companies.
“The correction could be more serious than expected if investors decide to sell their positions despite the danger of increasing tensions in the Middle East,” said Guillermo Hernandez Sampere, head of trading at MPPM EK in Eppstein, Germany, who expects a continuation of production cuts.
President Vladimir Putin spurred a spike in prices last month by suggesting that output reductions be lengthened until the end of next year. OPEC and Russia have crafted the outline of a deal to extend cuts to the end of next year, people involved in the conversations said Friday, although both sides are still hammering out details and the deal isn’t finalized. Russia supports proposals to extend the deal and various options are being considered, Energy Minister Alexander Novak told Russia’s RBC TV on Friday.
If major oil producers fail to agree to the deal’s extension on Nov. 30, oil prices could drop by $5 a barrel before the year-end, triggering a selloff in energy stocks, which will need to readjust to lower crude level expectations, according to Jason Kenney, an analyst at Banco Santander SA. In any case, investors have priced in OPEC’s constraint agreement lasting through mid-2018 and may use the meeting’s result to take profits, he said.
“Russia is playing it canny and will continue to monitor the state of the oil market before actually committing to continued supply restraint beyond end-March,” Kenney said by email. “I see little reason for oil to outperform a potential rising broader market in 2018. In the absence of a significantly stronger oil price, the oil sector is likely to remain very much in transition.”
Still, some analysts remain optimistic, with Credit Suisse saying it sees “more attractive” risk-rewards in oil and gas equities than in the oil commodity because of valuations, positioning and sentiment.
“As long as Russia and OPEC are committed to rebalancing the market in 2018, which we assume is the base case, de-risking of an above $60 oil price scenario for 2018-2019 can lead to a rerating of the stocks, particularly on the small and mid-cap side of the universe,” Credit Suisse analysts Ilkin Karimli and Yaroslav Rumyantsev said in a note.