Weekly Trends

Ryan Lewenza, CFA, CMT, Private Client Strategist

February 27, 2015

Oil Outlook H2/15 Recovery

Equity Market YTD Returns (%)

The West Texas Intermediate (WTI) oil price is down a remarkable 45% since its
July 2014 peak of US$107/bbl. In our view, the price shock has largely been
supply-driven, rather than demand-driven. Through this challenging period for
prices global oil demand has remained strong at 94.7 mln bbl/day in Q4/14, up
1.5 mln bbl/day from the previous quarter.

S&P/TSX Comp

S&P/TSX Small Cap

Interestingly, history points to a near-term bottom in WTI. We looked at

previous +40% oil declines over the last three decades and calculated the
average oil price recovery following a 40% drop. Based on historical patterns,
this signals a low in the coming months. This would align with our US energy
analyst, Pavel Molchanov and Chief Investment Strategist, Jeff Saut, who see
higher prices later this year. We concur, believing oil is likely to consolidate in
H1/15 before moving higher in H2/15.

3.3

S&P 500

2.4

Russell 2000

2.6

MSCI World

It is estimated that the global oil market is currently oversupplied by 1 to 2 mln

bbl/day, or roughly 1% of daily oil demand. With OPEC drawing a line in the
sand, and deciding not to cut production to balance the market, it will likely
come down to US producers to trim production and balance the market.
This has started to playout as seen by the material reduction in US rig count
over the last few months. As of February 20, the US oil rig count declined to
1,019, which is down 29% Y/Y and 37% since the October 2014 high of 1,609.
While rig count is down significantly, this has not yet triggered a decline in US oil
production, which as of last week was at a 30-year high of 9.28 mln bbl/day. We
believe there will be a lag in US oil production levels, as rig count reflects more
on exploration & development rather than actual production.

4.3

3.8

MSCI Europe

13.9

MSCI EAFE

6.0

MSCI EM

3.9
-3

Canadian Sector

Curr. Wt

10

13

15

Recommendation

Consumer Discretionary

6.6

Overweight

Consumer Staples

3.7

Market weight

Energy

20.9

Market weight

Financials

34.5

Overweight

Health Care

4.8

Underweight

Industrials

8.5

Overweight

Information Technology

2.5

Overweight

Materials

11.6

Underweight

Telecom

4.8

Market weight

Utilities

2.2

Underweight

Level

Reading

Technical Considerations
S&P/TSX Composite

15,259.6

50-DMA

14,691.1

Uptrend

200-DMA

14,885.6

Uptrend

64.9

Neutral

RSI (14-day)

Chart of the Week

Historically Oil Has Rallied Sharply One Year After +40% Declines In WTI
40%
30%

16,000
15,500

Average Return After 40% WTI Declines ('85, '91, '98, '01, '09)

15,000

WTI Return For Current Cycle (2014-15)

14,500

20%

14,000

10%
0%

13,500

-10%

13,000

-20%

12,500

-30%

12,000

-40%

11,500

-50%

11,000
Jul-12

-60%
Jul-14

S&P/TSX
50-DMA
200-DMA

Oct-14

Jan-15

Apr-15

Jul-15

Jan-13

Jul-13

Jan-14

Oct-15

Source: Bloomberg, Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 5

Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2.
2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

Source: Bloomberg, Raymond James Ltd.

Jul-14

Jan-15

Weekly Trends

February 27, 2015 | Page 2 of 4

Oil Outlook
The WTI oil price is down a remarkable 45% since its July 2014 peak of US$107/bbl.
In our view, the price shock has largely been supply-driven, rather than demanddriven. Through this challenging period for prices global oil demand has remained
strong at 94.7 mln bbl/day in Q4/14, up 1.5 mln bbl/day from the previous quarter.
Moreover, global daily oil demand has remained above the 90 mln bbl/day level
since early 2013. Continued healthy oil demand supports our view that the weakness
in the oil markets is largely a supply problem. It is estimated that the global oil
market is currently oversupplied by 1 to 2 mln bbl/day, or roughly 1% of daily oil
demand. With OPEC drawing a line in the sand, and deciding not to cut production to
balance the market, it will likely come down to non-OPEC producers, in particular the
US, to trim production and balance the market. So far, this has yet to show up in the
data.
We believe finding equilibrium in the oil market will start with a reduction in US rig
count. Baker Hughes publishes this data weekly and we have witnessed a material
reduction in US rig count over the last few months. As of February 20, the US oil rig
count declined to 1,019, which is down 29% Y/Y and 37% since the October 2014
high of 1,609. We believe this is the first step to finding equilibrium in the oil
markets.
While rig count is down significantly, this has not yet triggered a decline in US oil
production, which as of last week was at a 30-year high of 9.28 mln bbl/day. We
believe there will be a lag in US oil production levels, as rig count reflects more on
exploration & development rather than actual production.
With supply still plentiful and global production remaining high, we believe oil prices
could remain under pressure through the spring. The International Energy Agency
(IEA) forecasts a decline in demand in H1/15, but then an improvement in H2/15.
With our expectation that US production will begin to slowly decline in the coming
months, along with stronger demand in H2/15, this could set up oil for a stronger
second half.

Global Oil Demand Remains Healthy

US Production At Record Highs Despite Declining Rigs

98
96

1800
Global Oil Demand (mln bbl/day)
IEA Forecast

US Oil Rig Count (LHS)

US Oil Production (mln bbl/day) (RHS)

1600

9.5

1400

94

8.5

1200

92

7.5

1000

90
88
86

800

6.5

600

5.5

400

84

4.5

200

82

0
Q1/12

Q3/12

Q1/13

Q3/13

Q1/14

Source: Bloomberg, Raymond James Ltd., IEA

Q3/14

Q1/15

Q3/15

3.5

'06

'07

'08

'09

'10

'11

'12

'13

'14

'15

Weekly Trends

February 27, 2015 | Page 3 of 4

H2/15 Recovery
While the first step to finding equilibrium in the oil markets through lower rig counts
is occurring, we still see numerous headwinds to oil prices which could cap upside in
H1/15. Key headwinds to oil prices in the near-term include:

Strong US dollar: The current oversupply of oil (1-2 mln bbl/day) has clearly
weighed on oil prices. However, other factors are at play with the strong US
dollar being front and center. In the accompanying chart (sidebar) we
illustrate the strong relationship between the US trade-weighted dollar
(inverted on the chart) and oil prices. There is a tight fit between the two,
with a high negative correlation of -0.97 since early 2014. As the US dollar
has rallied 16% since January 2014, WTI oil has experienced a
contemporaneous decline of 50%. Given our view that the US dollar could
trend higher still, this could continue to provide a headwind to oil prices.

Strong US Dollar Is
Weighing On Oil Price
$110

Record inventories: The second major headwind to prices in the near-term

is the record amount of US inventories. As of last week US inventories stood
at 425 mln bbls, which is the highest level recorded on data going back to
1982. This excess inventory will need to be worked off before oil can
experience a sustained move higher, in our opnion.

75

r = -0.97

$100

79

$90

81

$80

83
$70

US production: As previously covered, we believe US oil producers will need

to cut back on production in order to address the oversupply. We expect
this to occur in the coming months.

85

$60
$50

Weak technicals: Given the technical damage to oil prices, there requires
much healing in the charts before we can declare the end of the bear
market in oil prices. Key technical levels for WTI include US$51 (50-day MA),
US$55 (short-term downtrend), and US$64 (100-day MA).

$40
Jan-14

87
WTI Oil Price (LHS)
89

US Trade Weighted Dollar Inverted (RHS)

91
Mar-14

May-14

Jul-14

Sep-14

Nov-14

Jan-15

Source: Bloomberg, Raymond James Ltd.

Interestingly, history points to a near-term bottom in WTI. We looked at previous

+40% oil declines over the last three decades and calculated the average oil price
recovery following a 40% drop. Based on historical patterns, this signals a low in the
coming months. This would align with our US energy analyst, Pavel Molchanov and
Chief Investment Strategist, Jeff Saut, who see higher prices later this year. We
concur, believing oil is likely to consolidate in H1/15 before moving higher in H2/15.
The key question in our view is whether we see a V- or U-shaped recovery. We are in
the U-shaped recovery camp, which translates into a period of consolidation (as
excess supply is worked off) followed by a recovery in oil prices in H2/15. This is our
projected playbook for oil prices in 2015.
History Suggests A Bottom In The Coming Months
40%
30%

Average Return After 40% WTI Declines ('85, '91, '98, '01, '09)

But Unlikely Until Record Inventories Recede

450,000

WTI Return For Current Cycle (2014-15)

20%

400,000

10%
0%

350,000

-10%
-20%

300,000

-30%
250,000

-40%
-50%
-60%
Jul-14

US DOE Total Oil Inventory (in thousands)

200,000

Oct-14

Jan-15

Source: Bloomberg, Raymond James Ltd.

Apr-15

Jul-15

Oct-15

'82

'86

77

'90

'94

'98

'02

'06

'10

'14

Weekly Trends

February 27, 2015 | Page 4 of 4

Important Investor Disclosures

Complete disclosures for companies covered by Raymond James can be viewed at: www.raymondjames.ca/researchdisclosures.
This newsletter is prepared by the Private Client Services team (PCS) of Raymond James Ltd. (RJL) for distribution to RJLs retail clients. It is not a
product of the Research Department of RJL.
All opinions and recommendations reflect the judgement of the author at this date and are subject to change. The authors recommendations may
be based on technical analysis and may or may not take into account information contained in fundamental research reports published by RJL or its
affiliates. Information is from sources believed to be reliable but accuracy cannot be guaranteed. It is for informational purposes only. It is not
meant to provide legal or tax advice; as each situation is different, individuals should seek advice based on their circumstances. Nor is it an offer to
sell or the solicitation of an offer to buy any securities. It is intended for distribution only in those jurisdictions where RJL is registered. RJL, its
officers, directors, agents, employees and families may from time to time hold long or short positions in the securities mentioned herein and may
engage in transactions contrary to the conclusions in this newsletter. RJL may perform investment banking or other services for, or solicit
investment banking business from, any company mentioned in this newsletter. Securities offered through Raymond James Ltd., Member-Canadian
Investor Protection Fund. Financial planning and insurance offered through Raymond James Financial Planning Ltd., not a Member-Canadian
Investor Protection Fund.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual funds. Please read the prospectus before
investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The results presented
should not and cannot be viewed as an indicator of future performance. Individual results will vary and transaction costs relating to investing in
these stocks will affect overall performance.
Information regarding High, Medium, and Low risk securities is available from your Financial Advisor.
RJL is a member of Canadian Investor Protection Fund. 2015 Raymond James Ltd.