Hedge position in oil-vulnerable markets like India, says CLSA's Chris Wood

Emerging market investors -  both in equity and debt segmets - should hedge their positions in oil vulnerable markets like India and Indonesia with overweights in Russia and other oil producers, advises Christopher Wood, managing director, equity strategist at CLSA in his weekly note GREED & fear.

Wood believes that the oil price can go much higher in the current cycle despite the correction in prices seen in recent days. While the energy demand remains strong, there has been chronic underinvestment in creating new supply, he says, which could keep prices buoyant.

The silver lining for investors in emerging markets, according to Wood, is that a rise in in oil prices will see US dollar levels go south. 

“While a further spike in oil prices to the $120-150 level would ultimately contain the seeds of its own destruction by destroying demand, it would do a lot of damage in the short to medium term; though the good news for investors in emerging markets is that a much higher oil price is unlikely to co-exist with a much stronger US dollar,” he says.

Brent crude oil prices hit a four-year high of $80 per barrel recently, stoked by fears of an escalation in trade war between US and China, proposed US sanctions on Iran and Opec’s decision to extend oil quotas till 2018-end. However, prices have cooled off since then as some of these concerns eased. Even then, Brent crude oil prices are around 47 per cent higher at around $72 a barrel level currently compared to the year ago period.

“A much more near-term factor that could serve as a catalyst for higher oil prices is the American demand that the world should stop importing Iranian oil by early November. This is a big deal, if really enforced, since Iran accounts for about 5 per cent of global oil supply and it is far from clear that this supply can be easily replaced,” Wood says.

Analysts at S&P Global Platts, a leading independent provider of information, benchmark prices and analytics for the energy and commodities markets, also expect oil prices to remain elevated and forecasts a range of $75 – 80 per barrel over the next 18 months given the global developments.

US tariffs and China's retaliatory response, they believe, has emerged as a big risk for commodity demand and prices in 2018, alongside a slowdown in the Chinese economy and geopolitical uncertainty.

“While there are risks to the macro-economic picture, most notably in the biggest oil consumer China, the global demand trend for oil remains relatively strong. Higher oil prices could start to crimp demand for crude if they remain elevated, dragging on global gross domestic product (GDP) growth, with signs of concerns in places like Turkey and Brazil for instance, which could have a far greater impact on overall demand growth,” said Paul Hickin, associate director at S&P Global Platts.