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Investing in oil amid OPEC+ output cut and ESG concerns

Jovi Ho
Jovi Ho9/19/2022 08:00 AM GMT+08  • 6 min read
Investing in oil amid OPEC+ output cut and ESG concerns
How can investors navigate the market as OPEC+ attempts to bring oil prices closer to reality? Photo: Bloomberg
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The Organization of the Petroleum Exporting Countries and its allies (OPEC+) will cut oil production for the first time in over a year, in a bid to lift recession-spooked prices.

Also known as OPEC+, the 23-nation coalition will reduce output by 100,000 barrels per day (bpd) in October. The Sept 5 announcement is an about-turn from its last meeting on Aug 3, where OPEC+ announced an equivalent increase for September.

The move comes amid a “yo-yo market” this year, as described by Saudi Arabia’s energy minister, Prince Abdulaziz bin Salman.

In an Aug 22 interview with Bloomberg, Bin Salman bemoaned a disconnect from fundamentals and hinted at output cuts: “In a way, the market is in a state of schizophrenia, and this is creating a type of a yo-yo market and sending erroneous signals at times when greater visibility, clarity and well-functioning markets are needed more than ever to allow market participants to efficiently hedge and manage the huge risks and uncertainties they face.”

One oil expert is surprised by the move. “In my opinion, oil price of more than US$90 per barrel is certainly not low and above pre-Covid-19 levels. It looks like the hawks in OPEC+ had their day,” says Yaw Yan Chong, director of oil research at financial markets and infrastructure data provider Refinitiv.

Yaw says the cut is “largely symbolic” and will make little difference to the global market. “It’s the same as last month, when OPEC+ chose to add just 100,000 bpd of output. We are simply back where we were in August from a supply-demand perspective.”

See also: Following OPEC+ meeting, can oil serve as a hedge against inflation and recession?

Fundamentals of the oil market

Oil prices soared to almost US$140 a barrel in March after Russia invaded Ukraine. As recession fears grew, however, prices have receded below US$100 per barrel. How can investors navigate the market as OPEC+ attempts to bring oil prices closer to reality?

There are many fundamentals in the oil market that impact its price, both from the supply and demand perspectives, says Yaw.

See also: Futures and options for young retail investors beyond plain stocks

While OPEC+ meetings are closely watched by investors and corporates, they are but one such fundamental, Yaw adds.

Today, the primary driver remains sanctions imposed on Russia following its invasion of Ukraine. “The conflict is still ongoing and the Western powers are persistently looking to escalate economic measures that can be imposed on Russia, the latest being talk of imposing price caps on Russian oil exports,” says Yaw.

“All these sanctions have altered the supply-demand balance of the market, and investors should continue to keep an eye on further imbalances,” he adds.

On the demand side sits China, the world’s largest oil importer. According to Yaw, the Chinese economy is now weak following months of Covid-19 lockdowns. This is impacting its oil demand, and feeding the bear further. “The world is now gripped by fears of recession, amid high inflationary pressures due to escalating prices of basic goods. So, there are multiple things that investors should keep track of.”

Yaw believes that the latest move by OPEC+ will hardly move the needle — certainly not over the long term. “Apart from that initial knee-jerk reaction when the output cut was first announced. It won’t be long before prices are back to where they were before the announcement.”

OPEC+ is scheduled to meet again on Oct 5.

Stocks vs oil

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Compared to trading in the equity markets, investors new to oil contracts may face some difficulty accessing information. “The novice investor will probably be more familiar with the stock market than the oil market, and will know where to find information — such as company websites, annual reports with balance sheets — before making an informed decision,” says Yaw.

For oil contracts, however, information is largely behind paywalls, requiring “expensive subscriptions” that are meant for institutional players rather than retail investors.

That said, some free tools are available online. The OPEC Watch Tool, for example, had predicted with 79.49% probability that OPEC+ would maintain or slightly increase output at the Sept 5 meeting, beating the odds of a significant output increase or decrease.

The free web tool uses the New York Mercantile Exchange (NYMEX) West Texas Intermediate (WTI) crude oil option price to calculate the probabilities of certain outcomes from the nearest weekly and monthly options that expire around OPEC’s meetings.

Oil contracts are no doubt a more sophisticated asset class compared to stocks, and they also carry their own risks. “Investing in oil contracts will require investors to put up margins before they are allowed to trade, and there are days when the market is extremely volatile and the margins can be wiped out,” says Yaw.

Using and trading oil in cleaner ways

The Russia-Ukraine conflict has cast the spotlight on energy security, and the world is scrutinising governments’ approaches to reducing fossil fuel reliance.

According to Mervyn Tang, APAC head of sustainability strategy at Schroders, this highlights the importance of incorporating environmental, social and corporate governance (ESG) analysis into the investment process. “This helps to assess the long-term sustainability of companies and other organisations from the perspective of energy stability.”

Oil attracts many investors with its volatility. With growing concern over the climate impact of burning fossil fuels, could investors be washed away by the rising ride of ESG investing?

Yaw does not expect interest to wane in the short term. “We are talking about 10 years from now.”

Instead, an investor can stay environmentally-conscious while investing in oil micro contracts, says Yaw. “I would argue they are two different things.”

Micro WTI Crude Oil contracts, for example, let investors trade on a smaller scale to manage crude oil price exposure with greater precision. At one-tenth the size of benchmark WTI Crude Oil contracts, Micro WTI Crude Oil futures and options offer the same robust trading transparency and price discovery with smaller margin requirements.

At 100-barrel increments, investors can make their foray into oil contract trading with smaller capital sums and at relatively lower risk. Compared to the stock markets, which have fixed trading hours, the oil market trades nearly 24 hours a day, depending on the chosen market.

Says Yaw: “Investing in oil, especially through the financial markets, does not directly lead to polluting the planet. Oil micro contracts are typically traded on exchanges; the fees generated do not necessarily lead to more pollution. The two, in my mind, are mutually exclusive.”

Instead, Yaw believes oil companies are keeping pace with the market’s sustainability journey. “Companies, oil or otherwise, have been looking to reduce their carbon footprint, and more investment will help them get there faster.”

As the world transitions into a future with renewable energy, oil will find another purpose, says Yaw. “Oil use will always be there, just not in the way that we know today. I would argue that ESG is about reducing carbon emissions, not about abandoning the use of oil, and the world is trying to find ways to use oil in cleaner, more environmentally-friendly ways.”

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