Last week we celebrated our 15th birthday at MoneyWeek magazine.
A lot of things have changed in that time (the internet has upturned industries across the world, including our own). A lot of things have stayed the same (the massive influence of central bankers remains, and, in fact, has only grown).
But if there’s one market that provided more surprises than any other over the last 15 years, I’d say it’s oil.
And I suspect that’ll continue for some time…
The oil supply doesn’t look like falling any time soon
Since the turn of the millennium, the oil price has rocketed. It hit an all-time peak of around $147 a barrel in 2008. The financial crisis put a brief stop to that as global trade dried up and the market collapsed. But it rebounded sharply.
It pottered along at $100 a barrel or so – the market was almost boring. But then a combination of increasing supply from US shale oil and a generally subdued recovery finally knocked the oil price off its perch last year, and now it’s closer to $50 a barrel.
And now it looks like Saudi Arabia is settling in for a lengthy oil war.
The Saudi government spends a lot of money on keeping the population happy – or at least, quiescent. That spending went up a great deal in the wake of the ‘Arab Spring’.
At first, the big spending wasn’t a problem. With oil prices above $100 a barrel, Saudi Arabia could afford it. It doesn’t cost much for it to get oil out of the ground, so that equates to a lot of profit per barrel.
But with prices plunging, the cashflow has dropped sharply. And the spending hasn’t fallen to match. That’s a problem, given that beyond oil, Saudi Arabia doesn’t have a lot of revenue-raising options. Oil accounts for around 80% of the government’s annual income.
As a result, Saudi Arabia has had to dip into its savings. Its foreign currency reserves have fallen to a three-year low of just under $650bn, reports the FT. Meanwhile, the country has already started borrowing money on its domestic bond market.
Now it plans to borrow money internationally. And its debt-to-GDP ratio could be set to rise from 6.7% this year to 50% “within five years”, reports the paper.
Saudi Arabia is doing various other things to mitigate the impact of falling oil prices, such as reforming subsidies and all the rest of it. And all of this is likely to have an impact on its growth.
But the key point, I think, for investors is that this is not a flash in the pan. The country is battening down the hatches and getting ready for a long and relatively uncomfortable period of low oil prices.
This article is taken from our FREE daily investment email Money Morning.
Every day, MoneyWeek’s executive editor John Stepek and guest contributors explain how current economic and political developments are affecting the markets and your wealth, and give you pointers on how you can profit.
.
That’s not to say that the Saudis have got any better idea of where oil prices are going than anyone else does. Like the rest of us, they don’t have crystal balls. But what they do have is a lot of oil, and it seems pretty clear that they’re going to keep on pumping it.
This stance makes sense. If you’re a genuine monopoly provider of a commodity or product that people need, then you can do what you like. If you choke off supply, people can’t go elsewhere, so they just need to pay whatever you demand.
That’s not the position that Opec is in. It never has been, but it’s true now more than ever before. With the US pumping out shale oil at a rate of knots, there’s a new competitor in town.
It’s bad enough that Opec allowed the oil price to remain sufficiently high to encourage the widespread use of fracking in the first place. The last thing it wants is the US to start exporting oil as well. And so it’s keeping the taps open in order to hang on to its market share.
So it seems that oil bulls can’t hope for a sudden shift in policy by oil cartel Opec to get the price rising sharply again.
The demand outlook isn’t looking too healthy either
Meanwhile, the demand picture is looking weak too.
The International Energy Agency reckons that oil demand will rise by less than 1% a year until 2020. As the FT reports, IEA head Fatih Birol puts it down to the easing off of China’s rapid industrialisation. “We are approaching the end of the single largest demand growth story in energy history.”
However, it’s not just about China’s growth spurt slowing down. It’s also about energy efficiency and, increasingly, governments’ commitments to ‘low-carbon’ sources of energy.
In all, the IEA reckons prices will stay at the $50 a barrel mark until 2020, and we won’t see $85 a barrel again until 2040 (how they can imagine they can see that far ahead is beyond me, but then I’m not a trained professional economist).
Obviously, you have to take all of these predictions with a pinch of salt. All of these things are cyclical. When the oil price kept going higher, the talk was all about ‘peak oil’ and the end of days.
Now sentiment is turning – there’s more than enough oil to go round, we’ll never see times like the last decade again – you know the sort of thing. But I suspect the hyperbole will have to get a lot more aggressive before we see any sort of turnaround – something like ‘peak oil’ in reverse perhaps.
That doesn’t mean that there aren’t opportunities in the oil sector. The relationships between the share price of many oil companies and the actual price of oil can be tenuous at the best of times. We’ll be looking at those in future issues of MoneyWeek magazine (sign up here if you haven’t already subscribed).
But it does suggest that we can expect lower prices to last for quite some time. And in the longer run, if technology can keep progressing – particularly battery technology – then maybe we will get to the point where our falling reliance on oil makes it a far less politically important market. Which would be nice.