Jefferies: Fundamentals of the Oil Market Remain Favourable for Continued Price Recovery

For the majority of the year, the positive correlation between oil prices and the stock market was the highest since the 1980s. Earlier this month, the 200-day positive correlation between Brent Crude Oil and the MSCI World Index was at 46%. While the link between oil prices and the market has slowed down, investors continue to use oil to gauge global economic growth. Following Brexit, Jason Gammel, an analyst at Jefferies, gave his updated forecasts for oil’s global supply and demand.

Gammel believes that the the long-term fundamentals of the oil market remain favorable, and expects to see a continued price recovery with global inventories starting to decrease in the third quarter. In regards to his short-term outlook, the risk relating to Brexit and the resulting rise of the U.S dollar influenced his bearish opinion.

The UK’s decision to leave the EU had two major effects relating to the oil markets; global risk going up due to uncertainties surrounding the exit and the appreciation of the U.S dollar as investors look for safe-haven assets. Oil is traded in U.S dollars, causing oil prices to be reliant on the strength of the dollar. When the dollar strengthens, the price of a barrel of oil increases for the rest of the world. The analyst suggests that the biggest risk to his thesis of a balanced oil market by the third quarter is the current strengthening of the dollar leading to a decline in demand from emerging markets.

Britain is the first country to vote to leave the EU, which led to anxiety about the future of the Britain and EU economies. Gammel states that this won’t have a large long-term effect on oil markets because their economies are not energy intensive. UK demand accounts for 2% of global demand, while Europe accounts for 14% of demand. The analysts estimates show that a 10bp change in European GDP would only change oil demand by 5 kbd, while the same change in an emerging market would equate to a change of 25 kbd of oil demand.

Gammel expects continuing global growth and declining non-OPEC supply to lead to a balanced market. He predicts demand growth of 1.1 mbd in 2016 and 1.2 mbd in 2017 along with non-OPEC supply to decline by 1.2 mbd in 2016 and 0.5 mbd in 2017. According to TipRanks, Gammel has a success rate of 74% with an average return of 7.4% per recommendation.

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