Commodity insights reveal upside opportunities

Commodity prices fell through June and July on the back of ongoing U.S.-led trade disputes and the threat of a broader trade war that could decrease demand for raw materials.

However, commodity prices should soon rebound, and oil could see upside if certain factors converge, says a Scotiabank commodities report.

The Scotiabank Commodity Price Index declined by 2.7% month over month in June, and the London Metal Exchange index of six key industrial metals fell by nearly a fifth between early June and mid-July, in its steepest selloff since late 2011.

“While the likelihood that creeping U.S. protectionism spins out into a broader trade war has unfortunately moved from tail risk to plausible scenario, we believe that cooler heads will ultimately prevail,” says the report, adding that commodity prices should rebound through summer’s end.

Recent selling pressure came from the speculative side of the market, as macro sentiment soured, says the report: “Hedge funds and other asset managers reduced their net position in copper futures and options to the lowest level since 2016, unwinding the record-setting long position those same funds had built up only months earlier as a bet on a strengthening global economy.”

Today’s exaggerated bearish sentiment in metals contracts tips the balance of near-term risks to the upside as those positions normalize, adds the report.

In oil, the spread narrowed for the two main global prices—West Texas Intermediate crude (in the U.S.) and Brent crude—after an outage at an oilsands facility in June.

“Production is not expected to return to full capacity until mid-September, which should help keep WTI balances tight and the discount to Brent low,” says the report.

Investing in oil now

In its mid-year market outlook report, released in June, GLC Asset Management says it’s sticking with its positive return forecast for Canada’s energy sector.

Key is that the forecast isn’t solely predicated on oil prices continuing to climb.

“WTI prices north of US$55 should be enough to sustain current valuations,” says the report.

WTI stands at more than US$68 today. At such levels, GLC sees a gap between commodity and share prices—a gap “that we believe should narrow with energy share price gains,” says the report.

For example, if WTI prices hold above US$60, price differentials for Western Canadian Select remain stable in the mid-teens and the loonie stays range-bound to weak, “we see potential for the energy sector to trade back up by another 10% in the second half of 2018.”

Read: How to invest in commodities despite sector challenges

Headwinds for Canadian oil

Currently, the discount for western Canadian oil is higher than usual.

Canadian companies are unable to gain from higher world prices because pipeline capacity is inadequate to take products to market, Tom Whalen, CEO at the Petroleum Services Association of Canada, told The Canadian Press.

The association says it’s cutting its 2018 Canadian drilling forecast by 500 wells as pessimism continues to grip the industry despite higher global oil prices. It now expects 6,900 oil and gas wells to be drilled this year—200 fewer than were drilled in 2017.

Whalen says service companies are reporting minimal improvement in earnings and many are continuing to lose money despite benchmark New York oil prices that rose from US$50.17 per barrel a year ago to close at US$70.13 on Monday.

Meanwhile, natural gas prices continue to languish at levels that are often less than profitable thanks to competition from burgeoning U.S. shale gas plays.

Read: Natural gas a natural pick for investors

“In general terms, revenue numbers for our sector are up year over year but we note that several publicly traded Canadian service companies are reporting minimal improvement in the quality of bottom line earnings; many are sitting at near breakeven or are still in negative territory,” Whalen said.

“This is not sustainable from a business continuity and competitiveness perspective. It’s also a compounding symptom of the sector’s lack of attractiveness for investment.”

For more details, read the full Scotiabank commodities report and GLC Asset Management’s mid-year outlook.

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