UK taps into oil strength
Amit Parmar looks at the recent surge in oil price and its impact on UK equity income investors.
Look beyond the geopolitics
Geopolitical factors have played a crucial role in boosting energy markets of late. Iran is currently dominating headlines, given the US’s decision to pull out of the agreement that lifted economic sanctions in return for the curbing of Iranian nuclear activity. The possible return of US sanctions against the country could remove as much as 400,000-500,000** barrels per day from Iranian supply, which could have a material effect on the overall dynamic of the market. Meanwhile, declines in production from OPEC (Organisation of the Petroleum Exporting Countries) member Venezuela have added further upward pressure to prices as the country continues to deal with its economic crisis.
Leaving aside the geopolitics though, the underlying supply and demand dynamic in the oil market was already conducive to a rising price environment. Demand from both developed and emerging markets remains buoyant, with the International Energy Agency (IEA) warning of a possible deficit as demand begins to outstrip supply this year.
On the supply side, the effects of the decision by oil majors to cut capex following the market correction in 2015 are now being strongly felt. Chronic under investment in large-scale projects and a greater emphasis on shareholder returns are oft-overlooked factors supporting the recent rise in the oil price. Finally, production curbs by OPEC and other major oil producers since the start of 2017 have successfully removed some capacity from a market that had been suffering from a glut in supply.
Corporates committed to returning capital
Has this rally been translating into higher profitability at the corporate level though? Both of the UK-listed oil majors, BP and Royal Dutch Shell, have been beneficiaries of the rising oil price, but at the company level their discipline and commitment to delivering value to shareholders should also be acknowledged.
With the Deepwater Horizon spill now behind them, BP has disposed of non-core assets and rebuilt its balance sheet to the extent that at the end of 2017 it was able to engage in a series of share buybacks. Most crucially the company remains committed to a disciplined approach to capital expenditure and to returning cash to shareholders through dividends. Royal Dutch Shell, too, has learned its lessons from the market correction in 2015, trimming its upstream operations and offloading non-core assets in favour of delivering an attractive dividend to shareholders.
Following a period of restructuring and disposals, both BP and Shell now have a particularly benign scenario facing them, with robust demand and tighter supply supporting a higher oil price. This should serve UK equity income investors well, with both companies continuing to offer attractive dividends.
*Brent crude. Source: Bloomberg; data as of 16 May 2018.
** Sourced from Oilprice.com as at 7 May 2018.
Amit Parmar is a Client Portfolio Manager within the J.P. Morgan Asset Management UK equity team.
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