It can hardly have escaped your notice that oil has been in the news for the better part of this year. Not this time due to some ecological disaster such as a massive oil spill, but due to the huge price hikes and increased volatility of crude oil prices. The likely effects of this were alluded to in a recent Henry Woods editorial pointing out the knock-on effect across industry and finally reaching the ordinary consumer. All of us are end-users, notably at the pump, and we have seen continued rises here. This is notwithstanding the fact that oil is priced in dollars, and were it not for the relative weakness of this currency against the Euro and Sterling, such price rises would have been more draconian. Yet, what are the underlying causes of the upward price movement and continued volatility of oil? There are at least two main causes. It stems firstly from simple supply and demand. In broad terms whilst demand in Europe is flat, it continues to rise in the U.S. and more particularly in developing economies where China is the main driver. Estimates for its total importation for 2004 are in excess of 110 million tonnes. This represents some 57% increase in just 2 years. During the next decade, total oil imports are expected to more than double current levels! The second major factor is supply, and there are major problems here. The main OPEC producers are treading a very delicate balance between their paymasters and their populations, which are increasingly becoming radical. Production quotas have been increased but not enough to satisfy the market. In addition major producers such as Russia are embroiled in their own internal domestic difficulties with Yukos. Indeed, reports recently suggested that they are suspending exports to China, which will doubtless have a further ripple effect. Additionally, like many of the major Middle East countries, they are fighting increased terrorist threats. Terrorism, or the threat of it, is a leading cause of current volatility. Insurgents are continuing to target oil pipelines in Iraq and former communist states that are oil-rich. Closer to home, Turkey has not escaped this problem, particularly with the development of cross-border supply routes. In addition to the above, a further problem relates to changing and extreme weather conditions. This has reduced output in Mexico in particular, and down through South America. With much of Russia’s output curtailed during the harsh winter there, the last thing all the western economies need is a harsh winter in the U.S stoking up further demand. One bright spot for the U.S position is the build-up of the Strategic Reserve. The threat of a major terrorist-driven supply interruption has led the U.S to rebuild massively its Strategic Reserves. The President, however, does have the power to release supplies into the market in times of emergency. This has been used in fairly recent times to soften the market such as during the Libyan crisis. Ironically, the major rise in prices this year has meant that the U.S administration is sitting on a massively increased asset. However short of a major terrorist outrage, this is likely to be a paper gain and thus unlikely to dampen down prices. All of this uncertainty has an effect on world markets. Oil prices are now well over 40 dollars a barrel with prices having lately topped 50 dollars. Each hiatus in oil production sees a quick response in the market with corresponding falls or rises. When oil prices retreat, one notices a rise in the markets. When they rise, the market then falls. Such volatility does, however, create opportunities for certain types of investment strategy. Indeed, some fund types largely depend on such volatility. For all of us, continued oil price volatility is feeding through to increased prices. Major manufacturing companies who are major oil users are probably best avoided at this time as far as investing is concerned. So, with this in mind, where should one be investing? There are a number of options that can take advantage of the current situation. The somewhat tired European economies offer little prospect of ‘real’ growth compared to emerging markets. Both debt (bonds) and equities in developing economies offer increased potential Additionally a degree of volatility in world markets can provide a springboard for increased returns via hedge funds. Ironically, the oil price hikes restrict options for interest rate rises in general due to the adverse inflationary effect. This may, therefore, give further opportunities in selected bond markets. In times of ‘troubled waters’ it is even more important to seek out professional investment help. The team at Henry Woods can help lead you to calmer waters!
