Edison Investment Research

Brexit, Fed: a short squeeze

If in the short-run the market is a voting machine, as attributed to value investor Benjamin Graham, yesterday’s 3% rise in European markets represents a vote of confidence in the Remain campaign winning the UK’s referendum on Thursday and a consistently more dovish US Fed for the remainder of the summer.

Fed boxed in by yield curve

It is looking increasingly likely the US Federal Reserve has missed its chance to engage in a meaningful interest rate tightening cycle. Globally, 10-year government bond yields have fallen sharply – in many cases to new record lows, in part due to the recent US jobs data and in part the increasing uncertainty over Brexit. This flattening of the yield curve is a strong indicator for a period of sub-par US growth, even if survey data has, for now, improved somewhat during Q2. Whether or not we are looking at a technical US recession is perhaps, technical, as in any case a period of even weak growth is inconsistent with positive surprises for corporate profits and equities.

Oil and Gas Macro Outlook - Tightening market buffered by abundant inventories

Summary

Oil price volatility remains high with Brent crude having risen 17$/bbl or 51% since our latest published macro outlook in January 2016. Since then we have seen supply impacted by a 1.2mmbpd reduction in Canadian output due to wildfires, combined with underinvestment and instability- driven supply interruptions across OPEC members:  Venezuela, Libya and Nigeria. Some of these temporary supply impacts will reverse over the coming months; nonetheless, we expect the oil market to tighten over the course of 2016. Although record levels of inventory and uncertainty over the sustainability of emerging market demand growth may limit near term price gains,  longer term, we expect prices to rise to c.70$/bbl in-line with levels required to incentivise non-OPEC supply expansion. Our short term oil price assumptions remain aligned to EIA STEO forecasts at 43$/bbl Brent in 2016 and 52$/bbl in 2017.

BP Stat review - quick thoughts and highlights

The annual BP Statistical Review is the industry standard source for tracking energy trends, usage and sources.  Full details of the Statistical Review can be found here. This year’s edition was presented yesterday, with interesting commentary made on the statistics.

Beware of buy and hold

The last few decades of the 20th century represented a golden era for equity investment with an average compound annual return, including dividends, of 14% pa in the period 1973-2000 for the US, UK and Europe. In this century to date, the annualised rate of return has fallen to 5%.

Earnings forecasts: absence of a negative is not a positive

Profits forecasts for the US, UK and Eurozone have been stable for the last 2 months. In the context of last year’s relatively dramatic declines in profits expectations (the worst year in a decade) this is a welcome development for equity investors.

Exploration Watch - Porcupine Basin

The underexplored Porcupine Basin offshore Ireland attracted 80% of the applications in the recent 2015 Atlantic Margin Irish licensing round, and for the first time saw a significant number of awards going to major companies including ExxonMobil, Statoil, Nexen and BP. The area has become a focus of attention most recently as a result of Statoil’s 300-600mmbbl Bay du Nord discovery in the analogous Flemish Pass Basin offshore Canada, but is also the result of earlier work by a number of independent companies that kicked off a round of 3D seismic surveys in 2013. As a result companies such as Antrim Energy, Europa Oil & Gas, Petrel Resources and Providence Resources hold assets surrounded by major-held licences and are well positioned in the ongoing farm -out processes.

Brexit: Ultimately unlikely

Edison has not taken any formal position on the desirability or otherwise of the UK leaving the EU. We are however pleased to provide the following summary of the key issues.

First, we believe any discussion on Brexit should be placed in the proper context. Based on current polling data it is significantly more likely than not that the UK will remain in the EU in the two years following the referendum on June 23rd. Online polls may indicate a nation split nearly 50:50 on the issue, but online polls also proved significantly less accurate than telephone surveys in the UK’s most recent election.

M&A in the UK - is Brexit opening a (relative) value opportunity?

Whether down to the potential for Brexit or a widening current account deficit the decline in sterling over the last 6m has been substantial. On a quarter-on-quarter basis the trade-weighted value of sterling has fallen by 7%, representing a move of more than 2 standard deviations away from the mean.

Bonds vs Equity vs Oil

Despite the low oil prices and Genel’s recent significant reserve downgrade, today’s announcement by Genel that it will be buying back a portion of its outstanding debt is a testament of the management’s confidence in the business and the benefit of the company’s strong balance sheet. The 7.5% coupon bonds were trading at 55% of the issue price yesterday and implied a yield to maturity of around 30%, a material discount.