the coming oil crisis - fact or fiction?

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    The Coming Oil Crisis: Temporary Squeeze Or Longterm Investment Opportunity?

    Global demand for oil shows no sign of weakening. Yet oil reserves in the US are at their lowest levels since 1975, while in the advanced nations as a whole they are only enough to meet 28 days’ use. Is the strength in oil prices a temporary phenomenon, or is it signaling a longer-term investment opportunity?


    Martin Spring

    London - At more than $33 a barrel, crude oil is currently trading 17 per cent above its average price last year, instead of prices closer to $20 that the experts expected after the end of the Iraq war.

    Global demand shows no sign of weakening, as it often does this time of the year, with the northern hemisphere winter fading and with it the need for heating fuels. Oil stocks in the US, the biggest consumer, are at their lowest levels since 1975, while in the advanced nations as a whole they are only enough to meet 28 days' use.

    Is the strength in oil prices a temporary phenomenon, or is it signaling a longer-term investment opportunity?

    Several factors have been driving up oil prices:

    ► The most significant has been demand from China. Last year China accounted for more than a third of the global increase in demand and overtook Japan to become the world's second biggest importer (after the US).

    ► Supply disruptions in major producers such as Venezuela, Nigeria and Iraq have prevented a build-up of stocks from their low levels.

    The bears advance these arguments against investing in oil:

    ► With the economies of the US and China facing slowdown, and growth likely to remain sluggish in Europe and Japan, global demand for oil will go flat.

    ► Higher prices are encouraging exploration and development activity, especially in regions such as Russia, Central Asia and West Africa, to which the US and other importing nations look to reduce their dependence on Mideast supplies. This is going to boost output, especially in countries that don't belong to OPEC so are outside its control.

    ► Investor interest is a double-edged sword. At some point the speculators will take profits/cut losses, giving oil prices a sharp blow.

    ► OPEC members are renowned for cheating on their quotas. In January, for example, they were pumping an extra 1.3 million barrels a day. Supplies are likely to err on the side of abundance.

    Bulls counter with these arguments:

    ► Even with slowdown/low growth in the major economies, world demand is likely to continue increasing at a stable rate of around 2 per cent annually. The International Energy Agency is forecasting 1.8 per cent for this year.

    ► In the short term, the market is very exposed to supply shocks similar to those experienced last year. The amount of spare capacity available to deal with such shocks in less than 2 million barrels a day, or about 2½ per cent of global demand. Stocks are likely to remain low because of "just-in-time" business planning to hold down costs and reduce financial risk.

    ► Longer-term, supply isn't going to grow fast. The giant oilfields such as Saudi Arabia's Ghawar, Alaska's Prudhoe Bay and the UK's North Sea are approaching the end of their productive lives, and no fields of equivalent size have been found to replace them. The geological, infrastructural and political difficulties of developing new production, whether in the Mideast or elsewhere, will inhibit expansion.

    "The easy oil era is over," the Texas energy-resource investment specialist Matthew Simmons argued in a recent presentation.

    My conclusion?

    I think there is a persuasive case for a core holding of energy, and in particular hydrocarbons (oil and natural gas), in an equity portfolio. The simplest way to do this is through a collective fund such as the excellent Investec Global Strategy Global Energy - an offshore open-ended fund registered in Guernsey.



    Martin Spring specializes in writing about global investment strategy. A pioneer of personal financial journalism in South Africa and editor of several financial publications there, he is now the UK-based analyst/commentator for South African investment media. He has a particular interest in the Far East, which he has been visiting regularly for 38 years. He writes a regular column in the Financial Mail."
 
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