Oil has played a major role in the boom-to-bust Noughties, soaring to $147 a barrel less than a year ago, then collapsing to about $33 at year’s end. Even that grand master of successful investment, Warren Buffett, got caught out, buying a chunk of oil giant ConocoPhillips at the peak of the market.
Recently per-barrel prices have stabilised in the $40s. Where are they headed?
Oil collapsed when speculators fled because of a deteriorating supply/demand situation – high prices and a credit-squeezed fall in economic growth cut into demand, at a time when producers were stepping up output in response to those same prices.
Falling demand remains the big problem for oil. The International Energy Agency forecasts global consumption will fall this year by a million barrels a day. That may not seem much, given that world demand runs at about 85m barrels a day. But oil prices are very sensitive to shifts to the supply/demand balance at the margin.
Given the current tendency for all official bodies to be over-optimistic about the outlook for the world economy, I suspect oil demand won’t pick up for several years… and will then do so sluggishly.
Oil stocks in the tank farms of the developed nations are well above five-year average levels.
Commodities – except precious metals – are out of fashion with institutional investors and most speculators after last year’s bloodbath, with the former driven by fear to favour low-risk assets such as government bonds. So I don’t see a resumption of demand from those quarters.
However, there are many positives for oil:
• Supply is contracting faster than demand as producers both within the OPEC cartel and outside it cut production in response to the relatively low prices. Output in Saudi Arabia, the biggest supplier, is running at 1.7m barrels a day below the levels of last summer. North American output is forecast to fall by up to 1.3m barrels a day this year.
• Although the pressures of rising costs have abated, they are still double the level of five years ago, when crude prices were about the same as now, says Royal Dutch Shell’s chief executive, Jeroen van der Veer. Expansion plans for new high-cost production in sectors such as Canadian oil sands and deep-water Atlantic deposits are being slowed down or suspended.
• If prices stabilise as low as $35, not much below current levels, only two international oil companies, ExxonMobil of the US and Total of France, would be able to finance current investment programmes out of their cash flow, according to Bernstein Research. For the others, raising capital to finance investment would be difficult in the current risk-averse climate.
• The long-term case for scarcity in supply remains unchallenged. Governments in major consuming countries are committed to reducing their dependence on imported oil and developing output of expensive substitutes. Production from the big older fields is declining.
International companies are excluded from developing supplies from countries with big reserves, such as Saudi Arabia, while deposits they can access are increasingly expensive to develop because they lie deep under the sea, are in harsh climatic conditions, are expensive to process, and face the opposition of the environmental lobby.
• The economy of the world’s biggest consumer, China, continues to grow despite the global recession. Although its demand will fail to grow this year, longer-term it must continue to rise strongly as the Chinese grow richer and own many more cars.
• In countries such as the US, where automobiles are the essential mode of transportation for most families, although the recession will continue to act against demand for petrol and diesel, relatively low prices will have a neutralising effect on that trend.
A low-risk asset play
With the likelihood that oil prices don’t have much more downside risk (not below $35?), and could well bounce back (major research houses suggest perhaps as high as $70 this year for the benchmark West Texas Intermediate crude), oil is starting to look like a low-risk asset play.
Even Warren Buffett says “odds are good” that oil will sell in future for prices well above current levels.
I reckon that the oil majors, with their strong earnings and attractive dividend yields, and in some cases great financial strength – ExxonMobil (NYSE:XOM) has a cash pile of $30bn, Petrochina (SHA:601857) has access to the political support and capital of the Chinese state – increasingly look like relatively safe havens for investors in an otherwise bleak scenario.
• This article was written by Martin Spring and published in ‘On Target’, a private newsletter on global strategy. Email
Afrodyn@aol.com