The price of oil is now firmly above $100 a barrel (assuming you measure it by Brent, which most people do at the moment).
Investors seem to be taking this rather well. “We coped with it at $60 a barrel”, they think. “We coped at $80. We’ll do fine here too.”
I think they’re being too complacent. Even if the Middle East wasn’t in turmoil, oil at $100 a barrel can’t be great news for the global economy.
Throw in all that unrest and you have a recipe for a very nasty shock
The age of cheap oil is over
I was at an Institute of Economic Affairs conference yesterday – hence the unusually high number of ‘tweets’ I was sending out. (If you’re not signed up for Twitter, it’s a handy way to keep a breast of breaking news – follow me and the rest of the team here.)
The title of the conference, ‘The State of the Economy’ sums up what it was all about. Andrew Sentance – the Bank of England’s main proponent of higher interest rates – had a good go at explaining why the Bank should be worrying far more about imported inflation. Other guests discussed the future of the euro, emerging markets, and whether the government was cutting spending fast enough.
Sentance’s speech has gathered the most headlines today, as you might expect. But we’ve written plenty on the Bank of England this week already, and he didn’t say anything you don’t already know.
For me, the presentation by Fatih Birol of the International Energy Agency on the oil and gas markets was far more important. Birol didn’t pull his punches. “The age of cheap oil is over”, he said.
On the supply side, companies are being forced to hunt further and wider to find new oil sources and ‘unconventional’ sources such as tar sands. And on the demand side, as China gets richer, it’s only going to need more oil, mainly for transport purposes. In Europe, 500 in 1,000 people have cars. In China, it’s just 30 per 1,000.
Investors should be more wary of the turmoil in the Middle East
Concerns about Peak Oil and the difficulties of finding cheap new oil are nothing new – we’ve been highlighting them for years. But right now, with the world apparently shrugging off the unrest in the Middle East, it’s sobering to be reminded of just how dependent we are on the region.
In the next ten years, says Birol, 90% of growth in global oil production is going to come from countries in the Middle East and North African region. Iraq, in particular, is crucial to boosting supply. “Global oil markets cannot afford not to see a significant increase in Iraqi oil production in the medium term.”
Birol didn’t mention the current unrest specifically. But I find it concerning that the general market view seems that this process will just create yet another batch of fantastic emerging markets to invest in. I’d like to see democracy and a 1989-style liberation sweeping the region. However, it’s by no means guaranteed.
And if the turmoil in Bahrain spreads to Saudi Arabia, that would surely push the oil price higher. That could push fragile Western countries closer to the brink of another slump. The ‘Great Recession’ may not have been directly caused by high oil prices, but they didn’t help. Even if oil prices remain at their current levels, says Birol, then as a proportion of GDP, Europe will be spending as much on oil imports as it was in 2008 – when the oil price hit near enough $150 a barrel and the global economy collapsed.
It’ll take a long time to wean ourselves off oil
What about alternatives to oil? Natural gas is one obvious answer. It’s cheap and (for now at least) plentiful. And it’s found in more geopolitically hospitable locations, such as in the US. My colleague David Stevenson wrote about natural gas a few months ago – you can read his piece here: Profit from natural gas – the fuel of the future. And there are plenty of other interesting areas for investors, from nuclear to renewables, all of which we’ll be looking at in future issues of MoneyWeek magazine (If you’re not already a subscriber, get your first three copies free here.)
But the fact is that our transport infrastructure is set up for oil. It will take a long time to wean ourselves off it. As Tim Price puts it in his Price Report newsletter, “whether or not Peak Oil is upon us, oil as our primary energy will not be replaced in our lifetimes.” His preferred way to play oil demand is through “the ‘picks and shovels’ providers to the majors”. Tim noted some of his favourite stocks in the sector at our most recent Roundtable discussion – you can read the piece here: The 22 stocks our experts would buy now.
Our recommended article for today
Company chief executives will always find ways to boost their pay packages, often at the expense of the shareholders. And while you’ll never be able to outsmart them, you can profit alongside them. Bengt Saelensminde explains how.