Oil Sell‑Off Sparks Investment Opportunities

Demand concerns, trade tensions, and strong implied U.S. production are driving an oil sell-off, much like in fourth-quarter 2018, but the complicated backdrop may create investment opportunities.

Update: Suspected attacks on two oil tankers in the Gulf of Oman early on 13 June caused a spike in prices. We see this as transitory, but will continue to monitor developments related to these events and geopolitical risk more broadly.

In recent weeks, renewed trade concerns, slowing oil demand, and a notable acceleration in implied U.S. oil production have spurred a material sell-off in oil. Similar concerns caused oil prices to drop at the end of last year, which prompted OPEC+ (i.e., the Organization of the Petroleum Exporting Countries plus 10 additional oil-producing nations) to cut production, reversing policy set earlier in the year of increasing output ahead of a reintroduction of sanctions on Iran. While OPEC+ output is now near multiyear lows, we do not believe OPEC will abandon the production accord at its upcoming meetings in Vienna (likely in the first week of July) in order to meet revenue targets, given that last year’s experience – boosting output and needing to reverse course soon after – will be informing its decisions. Moreover, actual U.S. oil production may not be as strong as the implied data suggest.

All told, we believe this sell-off is overdone and that the current backdrop offers an attractive opportunity for investors, whether via owning commodities outright or via midstream investments.

Complicated backdrop: trade, production

Oil demand is quite leveraged to global trade and, as such, has lost demand momentum as global trade has faltered. Over the past month, markets have answered the trade tensions and repriced the likelihood of a U.S.–China deal, which in turn may drive some upside to oil demand. However, a recovery in economic activity would likely be a prerequisite for meaningful price appreciation in the near term. Longer term, the upcoming shift in the International Maritime Organization-imposed sulfur cap to 0.5% from 3.5% in waterborne shipping offers a positive catalyst for crude oil demand, particularly light sweet crude.

Another area of uncertainty is the speed of U.S. production growth. Real-time data is limited; the U.S. Department of Energy (DOE) bases weekly production estimates on lagged monthly data, which is subject to revisions long after initial publication. Petroleum economists often augment the lagged production data with an implied production estimate, calculated by including the unidentifiable portion of the oil balances with production. It is this latest string of implied production estimates that we find especially intriguing – and controversial: After largely flatlining during winter months, in part due to weather, U.S. implied production has surged from roughly 12 million b/d (barrels per day) in March to nearly 13 million b/d in May. This rapid increase, if real, would be unprecedented, and (remarkably) would have come just before new pipelines are set to ease the bottleneck in the Permian Basin.

Drilling into the implied data

Could U.S. production really have grown so quickly without a material increase in pipeline capacity? While producers continue to exceed expectations, it is curious that most indicators have not been directionally consistent. Specifically, daily natural gas pipeline data from oil plays has largely shown little growth the past five months, unlike last year, when output of both gas and oil were surging. Rig counts, unlike in 2018, have been falling, down 10% from December highs (according to Baker Hughes). In addition, estimates of completion activity in U.S. hydraulic fracturing have largely been flat the past 12 months (according to Primary Vision). Also, our top-down corporate sampling and bottom-up basin estimates struggle to corroborate this implied production surge. Lastly, physical crude oil has consistently been trading well backwardated (i.e., with a downward-sloping futures curve) in the Gulf Coast – typically a sign of a tight physical market – and Midland Basin prices have been improving as new pipelines near completion.

Implied output can be volatile, and we find this apparent surge in U.S. output tough to explain. But with U.S. inventories building sharply over past two months, rising U.S. output could once again hit the market, as it did in the second half of 2018. As new pipelines come online this year, just how far U.S. output will be above our year-end expectations of 13.4 million b/d will shape the oil price path.

Investor takeaways: midstream energy, roll yield

Looking ahead, we see two potential opportunities for investors. One is the U.S. midstream energy sector, which is the primary beneficiary of U.S. oil production growth due to the need to process, transport, store, blend, and export. We believe the midstream sector offers organic growth well above nominal GDP growth, along with attractive yields and attractive valuations.

Another strategy is to buy oil, typically via an allocation to a diversified commodity index with meaningful allocations to petroleum. Due to OPEC+ actions thus far, both voluntary and involuntary, the oil market remains quite backwardated, contributing to a positive “roll yield” for investors owning oil in addition to potential collateral yield. The likely commitment to continuing the OPEC+ production agreement should allow for this curve structure to remain. Roll yield has been a strong indicator of forward returns historically, and if the global economy remains on track, we see a similar opportunity today.

Learn more about investing in the U.S. midstream energy sector in our Viewpoint, “Tapping Opportunity in Oil and Gas Infrastructure.”


The Author

Greg E. Sharenow

Portfolio Manager, Real Assets

View Profile

Latest Insights



PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Deutschland GmbH Italian Branch (Company No. 10005170963), PIMCO Deutschland GmbH Spanish Branch (N.I.F. W2765338E) and PIMCO Deutschland GmbH Swedish Branch (SCRO Reg. No. 516410-9190) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Spanish Branch and Swedish Branch are additionally supervised by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act, the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and  203  to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008 and the Swedish Financial Supervisory Authority (Finansinspektionen) in accordance with Chapter 25 Sections 12-14 of the Swedish Securities Markets Act, respectively. The services provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-, Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services provided by PIMCO (Schweiz) GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia). This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is managed and operated independently. The reference number of business license of the company approved by the competent authority is (107) FSC SICE Reg. No.001. 40F., No.68, Sec. 5, Zhongxiao E. Rd., Xinyi Dist., Taipei City 110, Taiwan (R.O.C.), Tel: +886 (02) 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Av. Brigadeiro Faria Lima 3477, Torre A, 5° andar São Paulo, Brazil 04538-133. | No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. Investors should consult with their investment professional prior to making an investment decision.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.