No Respite from Dearer Oil
Rob Mackrill - Tue 06 May, 2008
Oil prices look set to continue higher for some months yet threatening weakened western economies.
“Time to sell oil and buy shares,” pronounces The Sunday Times headline.
Merrill Lynch reckons the commodities sector is the most overheated it has been since ‘73. All things farming is trendy too. Fertiliser stocks are the new dotcom and farmers are busy planting all available land.
The Sunday Times’ advice appears to have fallen on deaf ears. The following day, Monday, oil hit $120. Another record. Rebel attacks in Nigeria disrupted production and renewed Turkish action against Kurdish insurgents in Northern Iraq were given as reasons why. They combined to push West Texas Intermediate sweet light crude to $120.36. Brent Crude hit a peak too - $118.58. Nigeria and Iraq combined accounted for 5.5% of global production in 2006 according to BP. Where would the price go we wonder if Saudi - accounting for 13% - announced peak oil?
As it is Goldman Sachs weigh in with another oil price forecast this morning. It suggests the Sunday Times is at best a little early on their call. We could see $150-200 oil in the next two years they calculate as supply plays tortoise to the hare that is demand. Shell CFO Peter Voser reiterated last week they see a market that is well supplied but still think prices will rise from here. Morgan Stanley analyst Hussein Allidina reminds us:
“The global oil market currently has very little margin for error with spare capacity constrained.”
Brazil may have found an offshore “elephant” or two but the stuff is six miles below ground and requires a pushing of the technology frontier to develop. Whether that proves economically viable remains to be seen.
Predicting the peak and the duration of the up cycle in oil prices this time around remains a tricky one admit Goldman Sachs. As we’ve noted before, Jim Rogers is less shy on the broad subject of commodities in general. Expect the commodity bull to run to 2014 or beyond he says (adding he’ll shout when it’s time to get out!). And the key driver is the industrialisation of the developing world: first and foremost, China. And there consumption continues to rise in spite of the relentless rise of crude – up 25% this year alone. In China’s case its thirst comes with the added kicker of inventory stockpiling ahead of the Olympics.
So it doesn’t look like the strengthening headwinds of oil prices (or commodity prices generally) are going away any time soon. And that hurts everyone - from the car driving commuter at the micro level all the way up to UK plc. Ernst & Young’s Item Club reckon a $150 oil price could cut growth to nearer 1% or less next year and push up inflation. At $200 we could see 6% inflation by 2010 they warn. Mervyn King will be an experienced letter writer (to the Chancellor) should that day come to pass.
So while the eye of the credit market storm looks to have passed, commodity prices continue to agitate and could yet sink even the modest economic growth projections of the industrialised world.
Warren Buffett told the 31,000 faithful at the Berkshire Hathaway annual shareholder jamboree that the worst has passed for Wall St but not the man in the street. Those with mortgages that is. There’s a lot more pain to come for US mortgage holders predicts capitalism’s nearest thing to a rock star.
Berkshire Hathaway actually took a 64% earnings hit in the first quarter from derivative losses but with a $40bn war chest it’s a good time to be a value investor with an eye for a bargain. He’s shopping in Europe too and is rumoured to be adding to his insurance empire by buying RBS’s insurance business. Elsewhere, US private equity firm Apollo wants a piece of battered UK house builder Barratt. And another private equity house, Blackrock, is buying $15bn worth of subprime mortgage debt from UBS.
Another home builder, Bovis might find interest from value investors too, following a profits warning today. Buyer reservations collapsed 70% since it released year end results on March 10. The shares at 457.75p are down 2.8% today as at 12.30pm. From a 52-week high of 1,160p and against a tangible book value of 562p/share according to the caveated calculations of ADVFN.
With European bourses showing up red today and the FTSE100 down 44, last week’s optimism is starting to wilt under the pressure.
Regards,
Rob Mackrill
The Daily Reckoning
