Oil is a threat to the global economy – and a big opportunity for investors

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.

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18 Responses

  1. 18/02/2011, David wrote

    Bang on the money John.

  2. 18/02/2011, Tim James wrote

    Hmmm

    I reckon that the price of oil is somewhat irrelevant! What happens is that people’s priorities change – so, if oil, petrol, etc., is more expensive that it means that you pay more for petrol etc., and less on something else.

    As a private investor what really matters to me is how The Market is going to react. In the discussions about oil and other things my feeling is that sometimes not enough is written about how The Market will react. The Market is ‘fickled’. On one of my holdings the share price actually went up when the worst trading figures of the company’s history were announced. So, what’s going on?

    Luckly, I (as many Investors, I expect), take all commentary with ‘a pitch of salt’. If I’m at all skeptical I won’t move.

    So, I’d like to see more Market prediction personally. Not just commentary on what is happening!

  3. 18/02/2011, Mr. ERoEI wrote

    Does anyone know ERoEI of natural gas or shale gas?

  4. 18/02/2011, bertha vanation wrote

    Natural gas is not a viable alternative to oil, after all it’s not just the energy aspects of oil that make it so vital, for example it takes 7 gallons to produce one car tyre. Fertilisers are also produced from crude oil. No amount of NG or renewables is going to fill this void.

    Having said that this is a good article, it’s a shame the MSM don’t focus on this issue more, perhaps they are afraid of frightening the horses?

    http://www.planbeconomics.com/2011/01/31/peak-oil-and-the-new-boom-bust-cycle/

  5. 18/02/2011, Alex wrote

    Bertha, that is the sort of ignorant nonsense that is pedalled all over the web by poorly researched special interest sites. Of course natural gas is an alternative feedstock in artificial fertiliser manuafacture, and that matter manufacture of RUBBER car tyres, the clue is in the main ingredient.

    Even if your statement wasn’t erroneous your premise still would be as coal to liquid and gas to liquid technology is well advanced and certainly economic at $100+ oil.

    For the time being you can remove the tin hat, and venture out of the house, the apocalypse is ( dissapointingly for environmentalists and luddites everywhere not yet upon us ).

    Oh and watch out for a very sharp correction in the price of Brent crude over the next couple of months.

  6. 18/02/2011, Bertha Vanation wrote

    Alex,

    I’m not concerned about personal insults but for the greater good, I hope you’re right.

    Perhaps you could post some links to support your claims. I’d be very interested.

  7. 18/02/2011, ricardo wrote

    …and after all the stuff that’s kicking off in the middle east, and with the year that BP have had, together with new claims of significant oil spills (covered up) by American companies, I’m left wondering what is going to trigger this “very sharp correction” in Brent crude.

  8. 18/02/2011, Tim Price wrote

    @Tim

    You mention the market’s response to negative news and articulate a desire to see more market prediction.

    On the first point, the market is always ahead of events, or trying to be. The saying in the City is: buy the rumour, sell the fact. So if a company announces dreadful results, the share price can still rise – if the market anticipated even more dreadful results still.

    As to market prediction.. there are hundreds of thousands if not millions of intelligent people, all betting with their own money or as economic agents, attempting to second guess the market. I would humbly suggest that market prediction is a fool’s errand. Better to analyse the fundamentals, use the charts in a reactive sense, and keep your powder dry for the more compelling investment opportunities. Anything else, especially in the short term, is noise, and should be treated as such.

  9. 18/02/2011, missonet wrote

    Oil may be a fuel of the past. There is new engine development with an engine which runs on hydrogen, needs no silencer, is vibration free, develops the power of a F1 engine and is so light you can pick it up with one hand which could replace the jet engine and will vastly decrease the weight of giant aircraft and solve the Airport pollution and noise problem. Each home could have one running noise and vibration free generating all the power they need from new technology producing hydrogen from sunlight.

  10. 18/02/2011, missonet wrote

    There is new engine development with an engine which runs on hydrogen, needs no silencer, is vibration free, develops the power of a F1 engine and is so light you can pick it up with one hand which could replace the jet engine and will vastly decrease the weight of giant aircraft and solve the Airport pollution and noise problem. Each home could have one running noise and vibration free generating all the power they need from new technology producing hydrogen from sunlight.

  11. 18/02/2011, DavidR wrote

    Lets put interest rates up so sterling will increase in value against the dollar so reducing transport costs for all at the stroke of a pen!! Plus I will have an income from my savings at long last and start spending!! Those of you in debt, tough!

  12. 18/02/2011, Jeff wrote

    Hydrogen is a waste of time whilst we are still making it from oil!!!
    If anyone comes up with a Nuclear powered hydrolysis plant, perhaps that may just make it work.

  13. 19/02/2011, Mark wrote

    I think that gas is the future, both natural and syngas that can be obtained from coal, waste and biomas. Shell / Sasol already have a big GTL plant in Qatar and Oxford Catalysts are developing technology that can make it cost effective on a small scale for as little as $50 a barrel – and thats for the refined product.

    Gas is everywhere and the hydrogen is useful too for fuel cells, which are the answer to all our energy problems and not as far away as everyone thinks. They can also contribute in making wind and solar power more efficient by using the wasted power to separate hydrogen from water via electrolysis.

  14. 19/02/2011, Mr. ERoEI wrote

    I agree with Jeff.
    Hydrogen is waste of time… its energetic return is even weaker than oil’s.
    Pumping&mining up is still more cheaper than producing…

  15. 22/02/2011, Velocity wrote

    ‘Peak Oil’ is absolute BS.. there’s never been more countries with it or finding it.
    The hysteria-driven media deserve shooting for peddling this leftie garbage along with AGW, Bird-Flu, Mad Cow, Sars, have we had enough already?!!!

  16. 23/02/2011, Mr. ERoEI wrote

    Velocity
    You have to be blind or ignorant.
    US peak oil has been proven many times. The biggest oil consumer on the Earth is still more and more depend on crude oil imports. And new economic tigers like China enjoy oil as well.
    US oil production peaked in 70′s http://wasatchecon.files.wordpress.com/2010/11/us_oil_production_and_imports_1920_to_2005.png
    UK oil production and consumption
    http://www.crudeoilpeak.com/wp-content/gallery/net-importers/eia_uk_oil_production_consumption_1980_2009.jpg
    UK is dependent on oil from 2005
    World oil production could peaked in recent years…
    Just look at ERoEI (energetic return) that dramatically fell from 100 to around 20. It’s still more and more complicated to pump oil up to ground surface.
    I don’t believe Saudi Arabia is that oily rich as declared and can save the Earth.

  17. 25/02/2011, Critic Al Rick wrote

    QUOTE:
    ‘Sentance’s speech……..and he didn’t say anything you don’t already know’

    Well, I bet he didn’t say that:
    1) the BoE might effectively be being controlled by The Top Investment Bankers.

    2) much of the unrest in the World today might be being caused by The Top Investment Bankers via control of Central Banks via injudicious use of IRs.

    Did he?!!!

    No!! But you’ve got to wonder!!

    BoEs rate setting, to me, since 2003 (if not earlier) has been totally illogical; don’t you think?

    It created the Credit Crunch. Now what might they be up to?

    Inflating away their potential mortgage negative equity?

    Planning on us all, eventually, being tenants?

    Planning of robbing us all of our;
    a) Savings?
    b) Shares?

    If so, the General Public needs to UNITE and declare WAR on these BANKERS, NOW, before INFLATION has got any more of a grip!!

    Don’t say I didn’t warn you!!!!!!

  18. 25/02/2011, Critic Al Rick wrote

    QUOTES:

    Churchill:

    ‘Now this is not the end. It is not the beginning of the end. But it is, perhaps, the end of the beginning’

    Einsten:

    ‘A person should look for what is, and not for what (s)he thinks should be’

    Critic Al Rick:

    ‘The main person a deceiver is deceiving is him/herself”

    Wake up! Please.

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