The future for oil and energy markets

Andreas Ettl - Fri 04 Aug, 2006

...What the future has in store for oil and energy markets...The uninterrupted high demand, fuelled by (geo-)political crises and problematic supply situation, as well as the ongoing unsatisfactory search for alternative energy sources, ensure oil prices remain high and short-term price reductions are unlikely...

  
 
The uninterrupted high demand, fuelled by (geo-)political crises and problematic supply situation, as well as the ongoing unsatisfactory search for alternative energy sources, ensure oil prices remain high and short-term price reductions are unlikely.

On top of this we expect to see higher volatility of the oil markets, influenced by hedging and speculation businesses making a proper prognosis difficult. However, the effect this kind of energy speculation has on the total market should not be seem as dramatic as the media and some finance ministers (especially in Germany), tend to put it The oil price is certainly not around 80 USD a barrel because of speculators...

The future for oil and energy markets: High prices

With all anger about high oil prices (especially when you need to fill up your car!), never forget this:

One barrel of oil (159 litres) transforms to a price per litre of 0.50 USD or 0.27 GBP.

Depending on the additional treatment received from the refineries as well as the taxation by the finance ministers, the litre costs up to four times as much at European gas stations.

At the same time, you and us, and millions of people around the globe, are happily paying more for a litre of beer or wine than 0.50 USD. Even a litre of mineral water is often more expensive than a litre of oil.

In light of this, isn't it funny that the world rants about these "crazy oil prices"? Who's going on the barricaded when the beer gets more expensive? Or the movie tickets? Or the Italian ice cream across the street? We haven't seen any outrage about this yet. However, no one agrees to take a step back in his own personal mobility, and it seems most people almost expect this transportation fuel to cost next to nothing.

In today's world, we take mobility for granted. We fly to a business meeting in London or Frankfurt, back on the same day. Weekends are, if possible, spent with friends and family in the countryside...

It makes for food for thought whether these prices for a rare commodity are indeed too high? After all, it is the driver for cars, airplanes, trains, ships and finally the entire global economy.

The future for oil and energy markets: Cheap energy

In our opinion there is no such thing as a natural right to cheap energy. The market will in the end decide on the sustainable price. We doubt state-driven interventions or the Sunday talks of politicians will make any difference in the end.

It is interesting in this context to note that various banks such as Goldman Sachs, Deutsche Bank and JP Morgan now, as the oil price is at the top, expect significantly lower prices for the coming years. Such anti-cyclical thinking may sound less than typical, but it could fit into a different context: Higher oil prices would put more pressure on the companies and consumers, lessen the money left over to be spent on products and most likely act as a driver for inflation, all in all reduce the spending in a variety of areas.

This model has little to offer for banks, which after all make most money in positive consumer climates, so the "comforting" oil price prognoses by mid 2007 (53 USD/JP Morgan; 65 USD/Deutsche Bank) may be nothing but wishful thinking.

Jim Rogers, a well-known "Commodity-Bull", even believes an oil price above 100 USD to be possible. if forced to choose between the bank's opinion and Mr. Rogers’, we're inclined to give Mr. Rogers our vote.

Such a "100 USD scenario" would leave little room for an ongoing bull market on the stock exchanges as far as we are concerned. More than ever, it will be about finding the most promising individual investments and to identify special situations. Of course, we are happy to help you with that!

The future for oil and energy markets: What to invest in

Oil stocks and other "close" businesses (producers of oil drilling equipment for example), but also all other "conventional" oil energy titles (energy producers, distributors), remain an interesting addition to a portfolio, despite their incredible past performance. Even more so if the pressure for mergers increases, and interesting takeovers will enter the scene.

Different countries saw a return of nuclear energy that was not expected only a short while ago. According to media reports, China intends to build 32 new nuclear power plants (up from 10), India wants to build 30 new reactors (up from 16). By 2030, the existing 15 Ukrainian reactors will be upped to 26. In USA, where 104 nuclear power plants fuel 20 percent of the required energy, another 13 are currently seeking development permission. In the next 25 years, Russia plans to build 40 new nuclear power plants. In 2010, the first "floating nuclear power plant" (!) is going live off the coast of Siberia.

Put your money preferably on well-known names in the energy sector. Aspiring companies, which are often not much more than their high gloss brochure, are rarely worth considering. If you want to invest into the energy sector, you should get into solidly managed companies featuring an attractive valuation and a good market position. Continuously rising energy costs will force alternative energies to replace some part of the oil energy, and synthetic products and technical processes will be developed to support this. At the moment, the price pressure is not high enough for these investments to take off, so the oil will still be with us for a while...


Regards,

Andreas Ettl
for The Daily Reckoning