Is This The Start Of A New Super Cycle In Commodities?

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Betting on crude not as easy as it seems

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- Oil prices have doubled from their lows in February, when oil dropped to $27 per barrel. Savvy investors could have made a fortune if they timed their positions correctly.
- But profiting from oil prices is not as straightforward as one might think. The U.S. Oil Fund (USO), an ETF that tracks WTI prices, saw an influx of $3 billion over the past two years as investors tried to profit from movements in oil prices.
- However, while WTI gained nearly 50 percent in 2016, the U.S. Oil Fund only gained 6.6 percent. If the fund tracks WTI, what explains that disparity?
- The market contango is to blame, a situation in which front-month futures prices trade at a discount to futures further out. The USO fund holds front-month contracts, so at the end of each month the fund needs to purchase new contracts, eroding the fund's overall returns over time. So while oil prices rose throughout the year, USO hardly gained at all.
- An easier route could be investing in energy companies themselves, rather than trying to find exposure to commodity prices. The Standard and Poor's 500 Energy Index, which tracks large energy companies, gained 26 percent last year.

2. EVs growing from small base…but represent main source of future growth

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- EVs are a very small slice of the global auto market, and by all estimates, will remain a niche for years to come.
- However, that fact belies the importance of EVs. By the 2020s, the auto market could reach saturation and stop growing. Beyond that point, EVs will be the only source of growth, according to projections from Bloomberg New Energy Finance.
- Thus, the EV market will grow slowly at first, but could explode after it reaches a tipping point: growing investment will push down costs to the point at which rapid adoption and further cost reductions begin to feed on each other. This explains the large investments automakers are making on EVs.
- Moreover, it does not take much to upend the oil market. A surplus of no more than 2 to 3 million barrels per day, or 3 percent of global supply, led to the once-in-a-generation meltdown in prices beginning in 2014.
- EVs will begin to eat into oil consumption, and it might not take much to start to cause real damage to share prices of energy companies.

3. WTI/Brent spread determines U.S. crude exports

- U.S. oil exports rose throughout 2016, after the export ban was lifted in 2015.
- But exports have still been relatively muted, due to questionable economics of doing so. The profitability of exporting oil depends on the WTI/Brent spread. WTI has traditionally traded at a slight discount to Brent, and the wider the discount the more profitable exporting will be.
- The spread narrowed last year as U.S. production fell, limiting the upside of exports.
- However, analysts predict that output in the U.S. will rise - fresh drilling has already sparked a rebound in output, with production up 300,000 bpd since the summer.
- That should lead to a wider WTI/Brent spread, opening up a window for more exports.
- A key export terminal started up in Corpus Christi, TX in November, operated by Occidental Petroleum (NYSE: OXY). The terminal has a capacity of 300,000 bpd of exports.

4. U.S. exports to Mexico on the rise

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- Mexico became a net-importer of oil and gas products from the U.S. for the first time in 2016. Refined product imports from the U.S. hit record highs at the end of 2016.
- Refined product imports from the U.S. could exceed 1 million barrels per day in 2017. This is a remarkable turnaround from a decade ago, when the U.S. imported more than it exported to the tune of 1.45 million barrels per day.
- A few reasons for this: Mexico's economy is growing, its oil production is falling, and meanwhile U.S. oil and refined products exports continue to rise. Also, the poor state of Mexico's refineries are inhibiting their ability to meet demand, forcing imports to rise.
- U.S. Gulf Coast refiners are benefitting from the evolving relationship, including Valero (NYSE: VLO), and Marathon Petroleum (NYSE: MPC). Refined product exports from the U.S. to Mexico are valued at roughly $15 billion per year.

5. Russian rouble gaining value

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- The rouble appreciated against the U.S. dollar in 2016, rising in parallel with oil prices over the course of the year. The rouble has gained 20 percent since the start of 2016.
- But the rouble gained even more since the U.S. presidential election, as the Trump victory is seen as a boon to Moscow. Trump has made positive comments about Russia and Russian President Vladimir Putin, and his selection of ExxonMobil CEO Rex Tillerson to lead the State Department is also seen as good news for Russia, raising prospects of the removal of U.S. sanctions.
- Remarkably, the appreciation of the rouble has come at a time of dollar strength - the dollar is at its strongest level in more than a decade. Still, the rouble has made gains. The rouble is the only major currency to appreciate against the dollar since September.
- Russia's stock market, the micex, was also up 24 percent on the year.
- Rouble strength is not necessarily all good news. Russian oil and gas firms have been insulated somewhat from the oil price downturn over the past two years because they sell oil in dollars and pay costs in roubles. A higher rouble will raise the cost of production.

6. Commodities set to rise

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- After a half decade of contraction following the end of the commodity super-cycle, commodity prices rose substantially in 2016.
- Price increases for oil, zinc, copper and a few other commodities led to an increase in the Bloomberg Commodity Index in 2016, the first increase since 2010. The index gained more than 10 percent.
- Investors are hoping for further gains, but analysts advise caution.
- "I see a challenging year ahead, considering how much good news has already been priced into both industrial metals and oil," Ole Hansen, head of commodity strategy at Saxo Bank A/S, told Bloomberg. "The direction of commodities in 2017 will depend on China's economic growth trajectory, Trump's ability to deliver his growth plans without damaging global trade, the dollar and, not least, OPEC's ability to deliver the promised production cuts."
- Indeed, China is the greatest risk to price increases for commodities in 2017. China's GDP is expected to slow to 6.5 percent, the slowest rate in a quarter century.

7. Oil IPOs set to rise in 2017

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- The U.S. oil and gas industry only saw 13 companies launch an IPO in 2016, the lowest figure since 2009 in the depths of the financial crisis.
- However, Maynard Holt, CEO of Tudor Pickering Holt & Co., predicts a sharp rebound in 2017, with the number of IPOs rising to around 40.
- Depending on the valuations, that could rival 2014, one of the best years in recent memory, when 44 companies went public, accounting for $14.15 billion in offerings.
- Everything is adding up for 2017 to be a great year for oil IPOs, with new companies chomping at the bit, and investors looking for profitable plays as oil prices rise.
- Holt says the most interest will be for midsized companies - ranging between $2 and $4 billion - with little debt and assets in the Permian Basin, specifically.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.