Predicting what might happen next to oil is impossible in the short term but there is some certainty about the long-term picture. Who can say with any certainty what the price will be next week or next month? But 10 years from now, when the financial crisis is a chapter in the history books, I believe oil will have returned to the higher levels experienced in the summer.
Much ink has been spilled in an effort to predict the floor. The cost of extraction is significant in this debate as the sector would be unable to sustain prices below the cost of production. But the per-barrel price of production varies wildly according to the method used and location of the oil fields. Easily accessible fields can produce a barrel for as little as $20, whereas newer oil sands production (where the crude oil is separated from oil-heavy sand) is as much as $70-$90 per barrel.
But regardless of production costs, the ultimate driver of price over the longer term will be the conventional balance of supply and demand. Despite the oil price rout since the summer, demand is still rising while supply wanes.
Right now, slowing growth prospects have destroyed demand for oil. Consumers and the speculators, real or mythical, have retreated from oil at an alarming pace. Meanwhile, moves from Opec to reduce production have had no effect on the plummeting price.
But this is a cyclical downturn, albeit a severe one, rather than an indication that the secular trend in demand growth has reversed. Prices surged as a result of the expectation and reality of rapidly growing demand from China and India, coupled with ever-tightening supply. These two emerging nations (each with a population of one billion) are still growing. The global recession will, no doubt, reduce their growth projections next year, but, as China’s stimulus package illustrates, their appetite for progress remains.
Both countries’ oil consumption is less than two barrels per person per year. This is around the same as South Korea and Taiwan in the mid-1960s. Since then, South Korea and Taiwan have emerged from a modern industrialisation to consume almost 18 barrels per person per year. If, during the course of their industrialisation, China and India reach even a third of these levels of consumption, global oil supply will struggle to keep pace with demand and the price will inevitably rise.
What does this mean for investors in the regions involved in the production or consumption of oil? The EMEA region – Europe, the Middle East and Africa – produces much of the world’s oil so is well positioned to benefit from a long-term trend of price rises. It is, however, more complex than simply buying up the local producers. Much of the region’s production capacity, particularly in Saudi Arabia, is in private or state hands and therefore inaccessible to investors. Where it is possible, in, say, Russia or Nigeria, significant political or currency risk may be priced into stocks after a savage sell-off but is offputting to investors.
But in all of these countries, the benefits of rising oil prices are appreciated directly in the state’s current account through the tax revenues from producers and the wealth-spreading secondary impact of oil assets. The profits from oil seep into the infrastructure of oil-producing countries. Among the immediate beneficiaries are construction and engineering companies and the wealth trickles through the economy from there.
Essentially, if you still believe China and India will continue to grow in the coming decade and beyond, you must believe in a long-term rising trend for oil prices. This is good for the countries producing oil, all the way through their economies.
Nick Price is portfolio manager of the Fidelity International EMEA fund