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THE INVESTOR
oilingthemachine
With high oil prices and recession often going hand in hand,
the relative stability of crude over the past few years has been
good news for economies and consumers
Oil priced at $100 per
barrel hasn’t adversely
affected the global
economy
By Edward Russell-Walling
sector watch
oil
D
uring the summer,
anxieties over Ukraine, Iraq
and Libya pushed oil prices
back towards their recent
peaks. Since then they have
eased off again, but industry continues to
monitor them closely, and so should we,
because dramatically increased oil prices and
recession often go hand in hand.
In fact, the price of oil has been pretty stable
for the past three years, with Brent crude
broadly trading in a band of $100 to $115 per
barrel. Brent is the international oil price
benchmark, based on prices for crude oil from
the North Sea, including the Brent field itself.
We are addicted to hydrocarbons in all their
guises – oil and gas, plastics and other synthetic
materials.The fundamentals of energy,
transport and heating all depend to a greater or
lesser extent on them, and movements in their
primary prices ripple through industry, the
economy and, ultimately, our personal lives.
Tensions in the Middle East and Nigeria
helped to create a record spike in oil prices
during the summer of 2008, as Brent hit its
all-time high at more than $145 per barrel1.
Though it’s often overlooked, this was a strong
contributor to the 2008/09 recession,more
commonly associated with that year’s financial
crisis. Nonetheless, in a country such as ours,
price movements need to be significant if they
are to make a major impact.
Because petroleum products are so heavily
taxed, the inflationary effect is cushioned.
In the UK, for example, where taxes can make
up 61% of petrol prices, a 5% oil price
increase would mean little more than 2% extra
at the petrol pump.That works both ways –
when the price falls, less of the decrease makes
its way through to the pump.
There is little immediate prospect of a
substantial fall, however.The Organization of
the Petroleum Exporting Countries (OPEC)
has said it will defend $100 per barrel of oil by
reducing production if the price drops too far
below that level.
‘Oil priced at $100 per barrel hasn’t
adversely affected the global economy,’
observes StephenThornber, of Threadneedle
Investments and co-manager of the St. James’s
Place Strategic Managed UnitTrust.‘It seems
to be a price that consumers can manage, and
which allows oil companies to balance their
exploration budgets.’
Thornber thinks there is more risk of prices
breaking above the $115 mark if demand
outstrips supply.OPEC can turn off the taps to
support the price, but it can’t open themmuch
more than they already are. Libyan production
has never regained pre-revolution levels, while
Iranian output is curtailed by sanctions.With
oil majors reluctant to invest further in
Nigeria, production there has fallen and, while
output is building in Iraq, its security is far
from guaranteed. Even so,Threadneedle
predicts that prices will stay in the $100 to
$115 price band for a further 12 months.
Oil is always priced in US dollars, so the
actual sums paid by users in non-dollar
economies can be further affected by exchange
rate movements. For the past couple of years,
UK industry has benefited from a
strengthening pound and a weak dollar, albeit
that sterling has been weaker more recently,
and the sterling price of oil is at a two-year low.
Industry everywhere wages a continual war
on energy costs by striving to make processes
more energy efficient.The savings here are
incremental at best.Onshore wind energy
is starting to be competitive with oil and gas,
though northern Europe lacks the sunshine
for solar energy to compete without subsidy.
In the US, however, industry is enjoying a
cheap energy bonanza thanks to shale gas.
Abundant supplies of fracked shale gas have
forced down US energy prices.‘This confers
on the US an enormous competitive industrial
advantage,’Thornber says. He doesn’t believe
the UK and Europe can repeat the trick.
Here, shale production will be limited by
environmental concerns, water issues,
population density, differences in land
ownership and,most fundamentally, geology.
‘Our rocks are older and so tougher and more
expensive to exploit,’ he adds.
1
Balance sheet
With our addiction to hydrocarbons in
all their guises, any movement in the price of oil – as
seen in the summer of 2008 – will have an effect on the
economy and our personal lives.
