The violent leg-down in commodity prices that began in 2014 resulted in massive shocks to terms of trade for commodity-exporting countries, putting a great deal of pressure on their currencies and slowing the growth of their economies. The pain was felt predominantly in the developing world, where many countries are net exporters of commodities.
Oil has been a major pain point. Although oil prices fell dramatically, the feedback loops embedded in the industry’s cost structure stymied supply cuts and delayed the market rebalancing. That amplified the decline in oil prices to unsustainably low levels. Turns are impossible to call, but medium-term economics dictate that supply curves cannot tolerate $30 oil prices at these production levels. Something has to give.
The recent rebound in prices may or may not signal a bottom, but we believe that simply arresting the downward spiral is positive. From a macro level, the move is already affecting currencies and credit conditions, and soon may start impacting trade accounts and fiscal balance considerations. This could throw the powerful feedback loops we saw on the way down into reverse with self-reinforcing dynamics on the way up.
This would be positive for commodity companies, as well as companies domiciled in countries that have seen their currencies and economies devastated by falling commodity prices. Oppenheimer Developing Markets Fund typically has limited direct exposure to commodity companies.1 Our predominant exposure to commodity prices is through holdings in countries2 with commodity-linked currencies, which could greatly benefit from stabilization in prices.
One of the few holdings we have in the space is Novatek,3 a Russian oil and gas company that we’ve owned since 2008. We seek to invest in rare, extraordinary companies that have competitive advantages and interesting real options. Novatek’s story is one of growth and transformation. It started as a domestic gas producer developing low-cost fields in the north of Russia. It moved into the high margin liquids business, which transformed the company into an international player and diversified its revenue stream. The next chapter is in LNG. The company’s Yamal peninsular LNG project has garnered a meaningful cost advantage through the use of conventional onshore gas and most of its LNG output is under contracts with downside price protection.
Even with the challenging backdrop we’ve had over the past couple years, Novatek has been able to deliver strong cash flow. It is a great example of how the combination of an advantaged asset, prudent financial management and an entrepreneurial approach allows a company to run a profitable business in good, and not so good, times.
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1 As of 2/29/16, Materials and Energy represented 5.6% of Oppenheimer Developing Markets Fund vs. 13.9% for the MSCI Emerging Markets Index. Holdings are subject to change and are dollar weighted based on total net assets. The MSCI Emerging Markets Index is designed to measure equity market performance of emerging markets. The index is unmanaged, includes the reinvestment of dividends and cannot be purchased directly by investors. Past performance does no guarantee future results.↩
2 As of 2/29/16, Oppenheimer Developing Markets Fund held 26.6% in countries that are net exporters of commodities including, Russia, Brazil, Mexico, Colombia, Malaysia and Indonesia. Holdings are subject to change and are dollar weighted based on total net assets.↩
3 As of 2/29/16, Oppenheimer Developing Markets Fund held 2.4% in Novatek OAO.Holdings are subject to change and are dollar weighted based on total net assets.↩
Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, regulatory and geopolitical risks. Emerging and developing market investments may be especially volatile. Eurozone investments may be subject to volatility and liquidity issues. Investments in securities of growth companies may be volatile. Mid-sized company stock is typically more volatile than that of larger company stock. It may take a substantial period of time to realize a gain on an investment in a mid-sized company, if any gain is realized at all. Investing significantly in a particular region, industry, sector or issuer may increase volatility and risk.
These views represent the opinions of the Portfolio Manager at OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.