The price of oil is rising. Throughout July and August, the price of Brent crude oil edged higher – hitting over $115 last week. And that wasn’t supposed to happen.
As global growth slows, we’re supposed to need less of the black stuff. Then there’s all the shale oil production coming out of the USA – that should be depressing the price.
But oil is rising. And it’s beginning to cause serious problems.
Here in France, fuel prices are as high as they’ve ever been. And the French aren’t having any of it. President Hollande has promised to cut prices at the forecourt; he wants make the oil companies pay and kick it back to punters in the form of a tax break.
But by my reckoning, the French and everyone else are going to have to prepare for higher oil prices. Today, I’d like to explain why I think we are heading for a serious oil shock. And rather than suffer as prices rise, I’d like to show you how you could profit from the situation.
Believe it or not, oil is cheap
An awful lot of work and effort goes into getting your litre of petrol to the forecourt. It starts with exploration, the costs of which are mind-bogglingly high. You need to raise hundreds of millions, if not billions, if you want to drill offshore – and even then, you may not find anything. If you do, you still need to get it out of the ground from some remote and often inhospitable place. Then it’s got be transported, refined and then safely transported again before it reaches your local garage. And let’s not forget the government's take.
I mean, just the fuel levy and VAT make up about 60% of what you pay at the forecourt. Then there are all the taxes the government hits the oil companies with.
And yet, despite all of these significant costs, you can still get a litre of petrol for about £1.40. Crikey, I often pay that for a litre of water at the forecourt! Fuel is cheap.
But this happy situation won’t last. The recent run up in the oil price may stem from sanctions on Iranian exports and lost output as Hurricane Isaac shuts down production in the Gulf of Mexico, but don’t be fooled into thinking this is just a short-term hiccup.
Huge forces are driving the oil price
First, we have to look at the oil supply.
We recently noted how precious few investors are willing to fund oil exploration these days. The sector is deeply out of fashion. Yet we desperately need to find more oil. As recently as four years ago, the International Energy Agency (IEA) warned we’d need to invest a massive $20trn in exploration.
But it’s not happening. Money is hard to come by in the financial markets today, and even if you can get a load of cash and can make a find, you run the risk of a greedy government coming in and grabbing your bounty.
Of course, the industry hasn’t ground to a halt, but there’s nowhere near enough exploration going on. And that’s going to cause supply issues down the line.
Sure, OPEC countries can increase supplies from time to time. But there’s no doubt that reserves are dwindling. And supply will remain tight over the coming years. Then there’s demand.
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After the Fukushima disaster, the Japanese switched off their nuclear generators. Germany did the same. And while these guys may be able to find some new ways of producing a bit of sustainable electricity, the burden will fall mainly on conventional fossil fuels.
Then, of course, there is the growing demand from emerging markets. Despite what you may read, these economies are still growing – and some at a very healthy lick. Just take China. For the most part, China’s spent the last 20 years making stuff for the rich West to consume. Yet in the recently released five-year plan, they’re talking about doing it for themselves. That is, they’re looking to use some their resources to lift the living standards of their own folk. Energy requirements will grow for decades to come.
Short of a revolution in sustainable energy, the oil price will only rise. Well, that’s my take on it anyway. I totally see that new technology is helping to increase production, but I just can’t see it keeping up with global demand.
One last good reason to own oil
Oil is a ‘real’ asset. And real things are useful to hold if you’re concerned about the state of the financial world. And as I’ve just mentioned, oil is very much in demand. In my opinion, you should have a decent slug of exposure – maybe 10% of your portfolio.
Many of the oil majors should be a good bet. Like the explorers, they’re out of fashion and trading on multiples far below ten times earnings. For instance, Shell is trading at less than seven times earnings, with a 7% yield. Though there are risks – as we found out with BPs Mocando disaster – a 7% return looks enticing.
For the adventurous, there are some interesting opportunities in the exploration sector.
About six months ago, I recommended Agriterra – an interesting play on food and oil. And the oil side in particular is looking very interesting. The share has moved up from just over 3p to nearer 5p. That’s a fantastic return, and who knows whether there is more to come.
More recently I recommended Brazilian oil explorer HRT Participacoes. Again, this was a risky punt, but the payoff if you bought at the time could be huge.
There are many ways of getting exposure to the black stuff. Whatever way you do it, just make sure you’re in. Though oil and exploration stocks are out of fashion, I suspect the industry has a bright future.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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