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Five things to watch in 2021 after oil’s wild ride this year

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The oil sector was hit harder than almost any other by the pandemic.

Crude prices fell from near $70 a barrel at the beginning of the year to below $20 in April as lockdowns slashed fuel demand. Prices even briefly turned negative in the US.

After a short but highly damaging price war, Opec and Russia enacted record supply cuts to stabilise the market. But even then, companies were forced to rip up investment plans while European energy majors started to look to a greener future.

Line chart of Brent ($ per barrel) showing Crude oil rebounds but remains shy of early 2020 levels

As the industry’s turbulent year draws to a close there are, however, signs of a nascent recovery. Crude has crept back to $50 and some investors are betting that the oil cycle is turning, even as expectations of peak demand loom over the horizon.

Here are the five things to watch in 2021:

Oil demand

Average oil demand will probably rise by the most on record in 2021. But that is essentially where the good news on consumption ends for oil bulls, with demand expected to be well below pre-pandemic levels.

The International Energy Agency projects consumption will rise by almost 6m barrels a day in 2021 but will average just 96.9m b/d — still well below the pre-pandemic record of 100m b/d in 2019.

Oil demand was also originally forecast to expand by about 1m b/d in 2020 and 2021. That means consumption in 2021 should be at least 5m b/d below where it would have been without coronavirus. In 2009 — as the world economy was slammed by the financial crisis — oil demand fell by just over 1m b/d.

Demand losses come from three main strands. The biggest is jet fuel, with air travel expected to remain severely depressed, consuming 2.5m b/d less than before the pandemic.

Gasoline and diesel demand will fare better, but are expected to be restricted in the first half until vaccines are more widely available and will only reach 97-99 per cent of pre-pandemic levels, according to the IEA.

“The next two quarters may not be meaningfully different to now,” said Amrita Sen at Energy Aspects.

The final hit is from the economic fallout, ranging from less demand from manufacturing companies to fewer goods being shipped by sea.

Oil supply

The outlook for oil supply is more complex.

The collapse in prices in 2020 has sucked investment out of the industry while practical issues — such as social distancing on oil rigs — has delayed drilling programmes.

Then there’s the US shale sector. Shale transformed the oil and gas industry and its growth put Opec on the back foot for much of the past five years. 

But this relatively expensive source of supply has been hard hit by the crash in prices with US crude output falling from a record 12.3m b/d in 2019 to 11.3m b/d this year, according to the US Energy Information Administration.

Shale has stabilised in the second half of 2020, but the days of gangbuster growth are behind it for now. The EIA sees US supply slipping to 11.1m b/d in 2021.

However, one of the key variables for oil will be how shale and other producers respond if prices rise much above $50 a barrel — a level where most companies can cover their costs.

Globally, the IEA sees production outside of Opec rising by 500,000 b/d next year after falling 2.6m b/d this year.

“Whether oil prices can remain as high and keep these gains is still questionable,” said Bjornar Tonhaugen at Rystad Energy.

Opec and its allies

The mismatch between supply and demand puts a lot of weight on what Opec and allies such as Russia do.

They called off a month-long price war in April and agreed to cut almost 10 per cent of global oil production to rescue the market.

The deal was meant to taper, allowing countries to produce more as demand recovers. But a drawn-out crisis has left them stuck with more than 7m b/d of crude still offline. They are expected to meet again on January 4 to discuss adding back 500,000 b/d.

Tensions have risen within the group as they weigh renewed lockdowns against a desire to rebuild revenues.

The question of long-term demand is a cloud that hangs over the entire expanded Opec+ alliance, which has included Russia and other producers since 2016.

Fears of a renewed price war within the group are weighing on sentiment, analysts at RBC Capital Markets argue.

“Market rebalancing remains heavily dependent upon the output management of Opec+,” RBC said.

Geopolitics

The biggest geopolitical shift in 2021 will probably come early for the oil market, as Donald Trump departs the White House. Mr Trump became heavily involved with Opec decisions, pressuring Saudi Arabia to raise or lower production in return for his support.

President-elect Joe Biden is expected to be less hands-on with the cartel, but he may end up being no less influential. The potential revival of the Iran nuclear deal could result in Tehran adding close to 2m b/d of crude back to the market if US sanctions ease.

Tensions in some of the weaker oil producers, in Africa, Latin America and other regions, will also be closely watched. All have been hard hit by the drop in oil prices, threatening political stability.

Refining

One of the worst sectors of the oil industry in 2020 was refining. Crude was helped by Opec+ group’s supply management, but refiners have fewer levers to pull when demand crashes. That has meant low margins for much of the year.

Permanent plant shutdowns are widely expected to accelerate in 2021, especially in Europe, with consumption patterns shifting east.

If enough plants close, however, that should ultimately boost margins for those left standing.



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US stocks rise as investors weigh strong earnings against spread of Delta variant

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Equities updates

Stocks on Wall Street edged higher on Tuesday as strong company earnings and economic data offset worries about the spread of the Delta coronavirus variant and fears over another regulatory clampdown from Beijing.

The blue-chip S&P 500 was up 0.7 per cent by mid-afternoon in New York, its best performance in more than a week. The tech-focused Nasdaq Composite climbed 0.3 per cent.

Investor sentiment was lifted by June data for US factory orders, which typically feed into estimates of gross domestic product. New orders for goods rose 1.5 per cent on the month before, well above the consensus estimate of 1 per cent.

In Europe, another wave of strong earnings results helped propel the continent’s stocks to a fresh record. The region-wide Stoxx 600 index rose 0.2 per cent after Paris-based bank Société Générale and London-listed lender Standard Chartered reported profits that beat analysts’ expectations.

London’s energy-leaning FTSE 100 index rose 0.4 per cent, aided by oil major BP, which rallied after announcing a $1.4bn share buyback programme and an increase in its dividend.

Line chart of Stoxx Europe 600 index showing Strong earnings help propel European shares to record high

On both sides of the Atlantic, earnings have been strong. More than halfway through the US reporting season, 86 per cent of companies have topped expectations on profits, while in Europe 55 per cent have outperformed so far, according to data from FactSet and Morgan Stanley.

“The continued healthy earnings outlook is a key driver of our view that the equity bull market remains on solid footing,” analysts at UBS Wealth Management wrote in a note. Such a growth rate is, however, “flattered by depressed levels in the year-ago period,” they said. “But the results are still impressive compared with pre-pandemic earnings.”

Oil slipped in a choppy session as the global benchmark Brent crude fell 0.7 per cent to $72.37 a barrel on fears that the spread of the Delta variant could depress demand for fuel.

The seven-day rolling average for new coronavirus cases in the US, the world’s largest economy, have hit nearly 85,000 from about 13,000 a month ago, according to the Financial Times coronavirus tracker. Similar trends have taken hold in other countries as well as authorities race to vaccinate larger swaths of their populations.

A log-scale line chart of seven-day rolling average of newcases showing that US coronavirus case counts rise from just over 10,000 in mid-June to nearly 100,000 by early August

In Asia, investors were again focused on regulation after Chinese state media criticised the online video gaming industry, calling it “spiritual opium”. Shares in Tencent, the Chinese internet group, fell 6 per cent before announcing it would implement new restrictions for minors on its gaming platform. NetEase and XD, two rivals, dropped 7.8 per cent and 8.1 per cent, respectively.

The Hang Seng Tech index, which includes Tencent and its peers, dropped 1.5 per cent, lagging behind the wider Hong Kong bourse, which slipped 0.2 per cent. The CSI 300 index of large Shanghai- and Shenzhen-listed stocks was flat.

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday



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Why it might be good for China if foreign investors are wary

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Chinese economy updates

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy

The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.

In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.

But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.

One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).

The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.

Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles. 

Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.

And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.

But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.

This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.

As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.

That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.

Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.



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Square to acquire Afterpay for $29bn as ‘buy now, pay later’ booms

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Square Inc updates

Payments company Square has reached a deal to acquire Australian “buy now, pay later” provider Afterpay in a $29bn all-stock transaction that would be the largest takeover in Australian history.

Square, whose chief executive Jack Dorsey is also Twitter’s CEO, is offering Afterpay shareholders 0.375 shares of Square stock for every share they own — a 30 per cent premium based on the most recent closing prices for both companies.

Melbourne-based Afterpay allows retailers to offer customers the option of paying for products in four instalments without interest if the payments are made on time.

The deal’s size would exceed the record set by Unibail-Rodamco’s takeover of shopping centre group Westfield at an enterprise value of $24.7bn in 2017.

The transaction, which was announced in a joint statement from the companies on Monday, is expected to be completed in the first quarter of 2022.

Afterpay said its 16m users regard the service as a more responsible way to borrow than using a credit card. Merchants pay Afterpay a fixed fee, plus a percentage of each order.

The deal underscored the huge appetite for buy now, pay later providers, which have boomed during the coronavirus pandemic.

“Square and Afterpay have a shared purpose,” said Dorsey. “We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”

Adoption of buy now, pay later services had tripled by early this year compared with pre-pandemic volumes, according to data from Adobe Analytics, and were particularly popular with younger consumers.

Rivalling Afterpay is Sweden’s Klarna, which doubled its valuation in three months to $45.6bn, after receiving investment from SoftBank’s Vision Fund 2 in June. PayPal offers its own service, Pay in 4, while it was reported last month that Apple was looking to partner with Goldman Sachs to offer buy now, pay later facilities to Apple Pay users.

Steven Ng, a portfolio manager at Afterpay investor Ophir Asset Management, said the deal validated the buy, now pay later business model and could be the catalyst for mergers activity in the sector. “Given the tie-up with Square, it could kick off a round of consolidation with other payment providers where buy now, pay later becomes another payment method offered to their customers,” he said.

Over the past two years Afterpay has expanded rapidly in the US and Europe, which now account for more than three-quarters of its 16.3m active customers and a third of merchants on its platform. Afterpay said its services are used by more than 100,000 merchants across the US, Australia, Canada and New Zealand as well as in the UK, France, Italy and Spain, where it is known as Clearpay.

Square intends to offer the facility to its merchants and users of its Cash App, a fast money transfer service popular with small businesses and a competitor to PayPal’s Venmo.

“It’s an expensive purchase, but the buy now, pay later market is growing very rapidly and it makes a lot of sense for Square to have a solid stake in it,” said retail analyst Neil Saunders.

“For some, especially younger generations, buy now, pay later is a favoured form of credit. Afterpay has already had some success with its US expansion, but Square will be able to accelerate that by integrating it into its platforms and payment infrastructure — that’s probably one of the justifications for the relatively toppy price tag of the deal.”

Square handled $42.8bn in payments in the second quarter, with Cash App transactions making up about 10 per cent, according to figures released on Sunday. The company posted a $204m profit on revenues of $4.7bn.

Once the acquisition is completed, Afterpay shareholders will own about 18.5 per cent of Square, the companies said. The deal has been approved by both companies’ boards of directors but will also need to be backed by Afterpay shareholders.

As part of the deal, Square will establish a secondary listing on the Australian Securities Exchange to provide Afterpay shareholders with an option to receive Square shares listed on the New York Stock Exchange or the ASX. Square may elect to pay 1 per cent of the purchase price in cash.

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