Almost unnoticed, oil has been creeping up again. Since mid-January, Brent crude has climbed by 40% to a nine-month high of over $70. Concern over supply constraints explain part of the rise: last week, for instance, brought news of a strike in Nigeria, the world’s eighth-largest exporter, where violence had already shut off a fifth of its supplies. Iran’s plans to expand its nuclear programme also caused jitters.
Oil sector: balance of supply and demand tightens
But geopolitics aside, the balance of supply and demand is getting tighter. Opec has cut its output and the “risk to non-Opec supply seems increasingly skewed to the downside”, says Goldman Sachs. There has been a decline in production in Mexico and Norway, while output is also hampered by inefficient state companies – “think Venezuela” – and “too much oil is in politically unstable regions”, says Edward Hadas on Breakingviews.com.
On the demand side, the global economy remains strong; according to the US Energy Information Administration, demand is set to grow by 1.8% this year, up from 1.1% in 2006, and Barclays Capital notes that China’s net crude oil imports rose by an annual 25.5% to an all-time high in April. This year world demand is set to exceed supply by 0.6 million barrels per day, reckons the EIA. With US meteorologists expecting an unusually bad hurricane season, there is scope for a spike above last year’s record of $78 a barrel, as Handelsblatt points out. Moreover, current supply problems, the lack of major new discoveries in recent years and Asia’s ongoing industrialisation suggest prices are hardly likely to fall significantly any time soon.
Oil futures markets have priced in sustained high prices, says Tony Tassell in the FT: Brent is trading above $67 a barrel for delivery dates as far out as 2012. Yet despite all this, the oil sector is on a p/e of just over 11, compared with the FTSE 100’s 13.6 times, as analysts expect earnings to fall away. It is priced as a cyclical sector despite the “promising and stable” long-term outlook. That spells opportunity for investors.