OPEC & Healthcare
October 18, 2022
The Limited Impact of OPEC’s Output Cut
Last week the Organization of the Petroleum Exporting Countries (OPEC) announced a 2MM barrel per day production cut beginning next month. This came against the backdrop of high but already decreasing oil prices, early indications of a slowing global economy, U.S. pressure to avoid a cut (to support the U.S. consumer), and Russian pressure to make one (to support Russia’s government revenues). There is a lot of debate and accusations regarding the rationale and soundness of the decision, but we believe a larger question is being missed.
Will anyone actually cut production?
In our view, the answer is no for most of the countries. This is because despite a 43.9MM production quota, OPEC-aligned countries are producing only 40.0MM per day. The production shortfall has been growing steadily since late 2021 as countries maximized output without investing in the infrastructure required to increase output. Continuous ESG pressure, a decade of lower oil prices (briefly negative during COVID), and an accelerating shift to EVs, it is no wonder that most OPEC nations looked to diversify from oil rather than double down on it.
The result is many countries pumping at maximum capacity, well under not only pre-pandemic output but also allowable quotas. The shortfall is 3.9MM barrels per day, bigger than the entire quota cut. In fact, S&P Global estimates the production decrease will be less than half the target, at 780K, coming mostly from only two countries – Saudi Arabia and the UAE.
Controversially and unsurprisingly, Russia is the biggest winner as they will not have to cut at all. Already the largest laggard vs. quota, Russia currently produces 9.8MM barrels per day vs. a quota of 11.0MM. A lower quota has zero impact. Nigeria is not far behind, lagging its quota by -0.8MM, followed by Kazakhstan at -0.5MM and Angola at -0.4MM.
It is for this reason that we believe the output cut will have less of an impact on the global economy than many initially believed. In addition, any upward gaps in pricing will further encourage U.S. shale production, which continues to ramp up slowly and is well off its peaks. The market largely agrees – despite a ~10% move up to the high 80s, oil prices remain ~30% below this year’s peak of 124. In this case, at least for now, the OPEC bark is much louder than its bite.
Healthcare Attractive in a Downturn Market
Global equity markets are facing multiple headwinds: inflation expectation, the Ukraine/Russia war, Chinese growth concerns, and tighter monetary policy from most central banks. Fear of potential recession and a weaker global outlook has shifted sentiment to safe-haven investments, which have a history of providing defensive, stable growth and realizable earnings. Healthcare is one of our favorite picks among those defensive exposures.
The sector has consistently outperformed in down markets. The MSCI Healthcare index was down 20% vs MSCI World’s 40% in 2008, and it remains ahead of MSCI World by 8.5% YTD. In addition, it is the second fastest-earning growth sector since the 1990s, beaten only by the tech sector. Compared with tech, it is less likely to become unprofitable and offers better dividends. Interestingly, inflation is of less concern since pharmaceuticals, procedures, and the like services are mostly reimbursed by insurers and government.
Resilient demand supports the healthcare sector’s long-term growth. People are less likely to reduce spending on medicine when under tight budgets caused by inflation. The global aging demographic, delayed retirement, and shrinking labor force result in more spending on healthcare. Also, the sector structure itself has changed significantly in the last 10 years. Pharmaceuticals were more than 80% of the MSCI Healthcare index, while today, biotechnology, equipment & supplies, life science tools, and services have tripled in weighting, offering a broader opportunity set.
Healthcare offers attractive valuation metrics compared with traditional defensive sectors, such as the consumer staples industry. Healthcare stocks are trading at a discount (forward PE at 15.7x and 18.4x current P/E level). Last but not least, investors shrugged off the news of the new drug-price-control bill, given the proposal is to choose only the top 10 costly drugs as a starting point. The rest is still years away. Ongoing political inaction and Democrats’ ability to hold their slim majority in November suggest major reform is not a near-term risk.
As a result, we believe that healthcare stocks combine near-term defensive and long-term opportunistic characteristics beneficial to client portfolios.
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The MSCI World Health Care Index is designed to capture the large and mid-cap segments across 23 Developed Markets (DM) countries. All securities in the index are classified in the Health Care as per the Global Industry Classification Standard (GICS®).
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.