Citywire - For Professional Investors

Register free for our breaking news email alerts with analysis and cutting edge commentary from our award winning team. Registration only takes a minute.

Oil’s autumn tumble fans fears of economic winter

Oil’s autumn tumble fans fears of economic winter

The price of black gold has fallen after key producer nations like Saudi Arabia lowered prices, while demand from Chinese and European economies has been sluggish.

The oil price has fallen 29% since its peak in July. Last week Brent crude was trading at $82 per barrel, its lowest level since June 2012.

Saudi Arabia, the world’s top oil producer, has abandoned its customary restraint.

It has been offering price discounts to its Asian customers, hoping to encourage demand and win long-term contracts. Other Opec members have protested.

A price war could be on the cards. Meanwhile, increased production from Libya, Iraq and the US means there is excess supply.

On the demand side, there is weakness. Slower growth in China and sluggishness in European economies have depressed demand.

Mixed blessing

A decline in the oil price, though a worrying signal of lower economic growth, and bad for oil companies, is not wholly deleterious.

Oil-consuming nations, such as China, Hong Kong, India, Singapore, South Korea, and Turkey, stand to benefit.

It is also good for Europe as the European Central Bank will keep rates lower for longer on a subdued oil price, because its measure of inflation includes energy prices.

COMMODITIES: OIL

Growth 2/5

Sticky patch

Both supply and demand factors lie behind the recent fall in the oil price. Opec is in disarray, and demand from China is disappointing.

Prices below $100 are not sustainable for many oil producers: that suggests prices could rise again in the medium term.

Sébastien Lagarde, manager of the AXA WF Framlington Junior Energy fund, said the price drop was temporary.

‘We believe this is a temporary experience, not reflective of the long-term outlook,’ he said.

Risk 4/5

Incendiary

Oil is not only volatile, but it has a big economic effect. Saudi Arabia can weather lower prices for a time. Not so Venezuela, whose economy is vulnerable.

Russia, Malaysia and Colombia are also at risk if prices continue to fall.

Lower prices are good for oil consumers. Andrew Cates, economist at UBS, estimates that every $15 per barrel decline in the oil price transfers 0.5% of global GDP from oil producers to oil consumers.

Value 2/5

Slippery

It is not easy to determine a fair value for oil because it has no cashflows.

Michael Lewis, strategist at Deutsche Bank, has used 10 different methods, resulting in an average of $69 per barrel. But the range of his estimates across the 10 methods is wide, from $53 to $89.

In future the US could overtake Saudi Arabia and Russia to become the world’s largest oil producer, which could mean lower prices in the long term.

Quality 4/5

Gearing could squeak

Oil as an essential commodity has perfect quality, but oil equities are of mixed quality.

BP’s recent results showed the adverse effects of the lower oil price, but it can stand the strain.

It is the mid caps, especially the highly leveraged, which could get into difficulties if prices stay low.

Dilma Rousseff’s presidential re-election victory in Brazil is bad news for Petrobras, Latin America’s largest company, whose quality has been damaged by government interference and scandal.

Momentum 1/5

Slump

The fall since July has been dramatic, with prices reaching their lowest level for more than two years.

Much depends on Opec: if it reverts to discipline and cuts quotas, the oil price will recover, but currently there is no sign of that.

Long term, the cheaper production costs of shale oil could drag prices down.

Despite falls, oil is still expensive compared with its long-term average, even after adjusting for inflation. It traded near to $20 per barrel for most of the 1990s.

VERDICT

Oil has taken a surprisingly sharp fall, and it is by no means certain this is over. Some analysts are suggesting much lower prices would be reasonable.

The fall has hurt oil equities, and could damage the more vulnerable producer nations, though it is good for consumer nations.

HOW TO PLAY IT

The oil price can be accessed via ETFs. If you prefer oil companies, Citywire Discovery reveals that over the past three years in the Equity – Energy sector only four out of 16 managers we track have beaten the benchmark.

Three of them work for Guinness Asset Management. The fourth is AXA Investment Managers’ Sébastien Lagarde.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.