Commodities | Apr 25 2006
by Chris Shaw (Tokyo)
China is the most common response to what is the main driver of commodity markets, but in the view of Dr Edward Morse, executive advisor at Hess Energy Trading Company, such a response is incorrect when describing the oil market.
The energy markets are as cyclical as any other commodity, Dr Morse suggesting the latest upswing in the energy market began only a few years ago, the catalyst being the exhaustion of the excess capacity created in the 1970s.
In Morse’s view, the exhaustion of this excess capacity has resulted in upward pressure on prices, but the driver of this pressure has been the US. As he pointed out to delegates at the Commodities Investment World conference in Tokyo yesterday, US demand has spiralled upwards over the past 15 years, its imports increasing from about 7.1m barrels daily in 1990 to almost 12m barrels daily by the end of 1994.
To put this increase in perspective, it represents almost the total daily demand of Japan, which imports 100% of its oil needs. In contrast, total Asian demand increased from about 17m barrels per day in 1990 to just over 20.5m barrels per day in 2004.
But it isn’t only increased demand that the US is responsible for, Morse noting the country has also destroyed supply in many cases as the world now has the lowest level of spare capacity in history.
Again to put things in perspective, he notes one doesn’t have to go back too many years to a time when total world output was about 85m barrels of oil daily, against total demand of around 62m barrels. Today, demand has increased to 85m barrels, but supply capacity is essentially unchanged at the 85m barrel mark, which is creating an environment where the oil price has almost no choice but to rise.
Morse gave some examples of the destruction of supply achieved by the US, pointing to trade sanctions on both Iran and Libya limiting their ability to invest in creating new capacity, meaning daily production in both countries has declined by as much as half since 1990.
Iraq is a similar story, as in 1990 it was producing around 3.4m barrels daily, but this fell to 2m barrels per day in 2004 thanks at least in part to the US’s involvement with that country both politically and militarily.
With the world oil market now suffering from a lack of spare capacity, disruptions to supply whether from deliberate actions or as a result of natural events such as last year’s hurricanes mean the market is constantly playing catch-up, creating a bullish environment for prices.
Morse believes this has encouraged speculators into the energy markets, but their risk has reduced significantly for two reasons. Firstly, the Saudi’s and other OPEC nations have shown the floor price for oil they are prepared to support has risen significantly in recent years, from US$28 per barrel to a current range of US$50-$55 per barrel.
At the same time, the acceptable ceiling price as indicated by the willingness of the US to limit the oil price through use of its strategic reserve has moved higher, as US policy has not been to respond to every price shock. The last example was after the hurricanes last year when oil briefly pushed above US$70 per barrel, but even now prices are higher and the US government has given no indication it is prepared to try to limit further gains.
Morse’s conclusion is oil and other energy prices look set to enjoy a few more years of gains, as the cycle appears to have several years left to run. His advice for those looking for the end of the cycle is to study leading indicators such as the lead time for new supply to come on line, as well as the impact any disruptions have in delaying this new supply from entering the market. He notes no substantial new supply is likely before 2009.
Morse’s presentation was following by a panel discussion offering suggestions for investors looking for a way to play energy markets. Among the panellists was Simmons & Company International’s head of European Institutional Sales, Mr Robert Muse, who pointed out major oil stocks were generally not expensive compared to where they should be valued based on current energy prices, these stocks offering the added advantage of being a lower risk way of playing the sector.
Muse also likes the oil services sector, as in his view there needs to be a massive increase in spending in the sector as producers attempt to meet the increasing demand. For those looking longer term to the end of the oil era, he suggests some alternative energy companies such as solar and wind power companies may be viable options in the future.