Carmignac: Oil Price Rally Will Last

Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Michael Hulme, Manager of the Carmignac Portfolio Commodities Fund.

Hi, Michael.

Michael Hulme: Hi, Emma.

Wall: So, if we look at what the oil price has done year-to-date, it rallied, it lost those gains and now it's rallied again. Is this rally for real?

Hulme: Well, obviously, I mean, in the short term, it's very hard to predict movements in oil prices. There's a lot of speculation, a lot of moving parts and people obviously hanging on week's inventory numbers, news out of China, for example. But I think the market has been missing a trick. Actually, I think there really is some sustainability to this oil price move. And the key is really, or the proof of the pudding, is really in the U.S. inventory data.

Now, everyone has been spooked since the beginning of the year by the continuing rise in U.S. inventories or stock piles, as easier to call them, and those stock piles always rise on a seasonal basis at the beginning of the year. There is more capacity than demand and therefore on a seasonal basis, you add to storage. Now, as we go into the summer months, we're really going to start to see the driving season in the U.S. kick in, demands generally picking higher and we'll see whether we really are seeing those declines in production come through in the storage numbers and I expect us to see that come through. I expect to see storage come down.

I expect to see crude drawers to really start to kick in as we saw in the previous week and that should have a beneficial effect on the oil price. So, I think the second quarter of this year, which we're already into, is really the litmus test for oil and I think we can be quite positive about the trend going forward.

Wall: I suppose though if the oil price goes up, does that not mean that more suppliers will come to the table? Those shale supplies in the U.S. that can just turn stuff back on?

Hulme: Yes, just turning stuff back on is unfortunately not as easy as people think. Now, you may remember when we talked last year about how long it really takes for shale production to come down after the price signal – the prices dropped. We finally started to see significant moves in shale production down 5% year-on-year, down 6%. The major basins like the Bakken and Eagle Ford now well past their peak. So, it's going to take a lot more effort and money to really turn that trend around.

We've had a lot of rigs idled. It's going to take time to get that capacity back on stream. A lot of people have lost their jobs. It's really going to take 6, 12, even 18 months before you can ratchet back up to levels even vaguely in the ballpark of where we were a year or two ago. So, that will take time.

Wall: How will OPEC react to that, because of course it has been OPEC and particularly Saudi that has kept the prices so low for this 18-month period? Will they welcome a return to a little bit higher prices?

Hulme: I think so. I mean, I think it's really difficult for those OPEC countries struggling as they are with sizable budget deficits. Young population in need of ever more subsidies, not very diversified industries, so heavily dependent on oil. So, they will be relieved about oil prices going up and you can see that in the language about a production freeze. Now, many people don't think that's very significant. I actually think it is quite significant because where has the incremental production come from over the last three or four years? It's not just been the U.S. It's been countries like Iraq where we've seen considerable gains in production.

And talk of a freeze, even the Iranians are moving towards a language that denotes some kind of upper limit to their production. That really helps to put a lid on potential supply coming out of OPEC. If we contrast that against a non-OPEC world, which is seriously constrained now, then I think that's quite bullish.

Wall: So, oil prices will go up but probably not to the levels we used to see a couple of years ago?

Hulme: I think there is every chance that oil prices mean revert and usually when oil prices mean revert, they tend to overshoot. So, cyclical commodities, like oil, don't tend to behave in a steady or flat pattern. So, there is every reason we will see an overshoot. People are too worried about Iran. We've seen a recovery of 200,000 or 300,000 barrels a day in Iranian production. It's going to take a lot more money and a lot more effort to bring that back on.

By the way, look at countries outside the U.S., like Brazil, we're really starting to see meaningful declines in Brazilian production. The recent figures I think showed for Petrobras down 5% year-on-year. So, things are tightening up.

Wall: Michael, thank you very much.

Hulme: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.