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Energy-indexed funds at risk from oil collapse

Energy-indexed funds could come under fresh pressure as fund houses are predicting that oil prices have more room to head south before bottoming out.

Earlier this month, Goldman Sachs forecast that the benchmark West Texas Intermediate crude could bottom out at $20 per barrel – a shift that casts a shadow of doubt on the viability of the North Sea oil fields and the outlook for oil-exporting countries such as Malaysia. Large investments in these regions were made while the price of oil was at $100 per barrel.

Principal Global Investors (Principal) noted that with breakeven costs of oil production at $55 per barrel, and present crude prices range-bound at $45 to $48 per barrel, prospects for the exploration and production sector are looking grim.

“Expectations call for a 200,000 b/d average drop in the second half of this year, from the 9.4 million b/d in the first half of this year, and a further 400,000 b/d drop next year. The number of active drilling rigs in the US is now 60% below last year,” Principal said in its latest research note.

Jim McCaughan, CEO of Principal told Fund Selector Asia in late-September that “oil, metals, and soft commodities are all basically in plentiful supply, so it is too early to buy [into] the commodities or the equity of commodity producers”.

Taking a cue from industry sources, Moody’s reported last week that “ongoing industrial commodity price deflation constitutes strong evidence of a sagging world economy“. 

“The price of crude oil has flirted with its lows of the Great Recession, while the base metals price index has slumped to levels last observed in the summer of 2009, or at the very start of the current recovery,” Moody’s noted in its research report. 

Impact of low crude on oil-exporting countries

Meanwhile, investors are also becoming cautious when it comes to allocating assets to oil-producing nations such as Malaysia.

“Cheap oil will continue to harm the economy, which makes me believe that [the country] will underperform moving forward. I don’t think political issues will be resolved anytime soon, so I find little reason to invest in Malaysia at this point,” Nitin Dialdas, founder and CIO of Mandarin Capital, told Fund Selector Asia.

Dialdas’ view is echoed by Mark Burgess, Columbia Threadneedle Investments’ CIO and global head of equities. Burgess told Fund Selector Asia that from an asset allocation point of view, he favours India, while he is underweight Malaysia. Burgess noted that investors should watch the fundamentals driving the price of oil carefully.

“Unfortunately, the only developed economy of any significance to have registered a strong growth post-crisis, the US, has been challenged by a stronger dollar and a tightening labour market, while capital expenditure has been hit by the global slump in oil prices. If the US begins to slow, and China slows quickly or worse, the prognosis for global growth is uninspiring. There are no other economies waiting in the wings to take the economic growth baton despite all the policy initiatives to boost growth,” Burgess said. 

Part of the Mark Allen Group.