Energy - it's what keeps us moving

One commodity that affects us all on a day to day basis is oil.  We regularly keep our eyes fixed on the petrol prices hoping they will not go up.  Global energy presents an interesting and compelling argument for investment.

Most of us will remember the credit crunch and how oil crashed from record high’s down to $30 a barrel.  Since then the price of oil has risen back up to recent high’s of $125 to settle around the current level of $110 (Brent Crude).  

Oil is traded on the futures market, and as such it provides an indication of market consensus for the price of oil for the next 8 to 10 years.  What would surprise many is that the futures curve is currently in backwardation (where current prices are higher than the future) and are pricing in around $85 a barrel over the long term.  This is somewhat interesting as the market believes this current oil price will decrease, but why?  This will happen in one of two ways, supply increases or demand decreases.

Although supply side we may see an influx from the U.S in form of the shale (tight oil) estimates may be somewhat over egged.  Also what many people do not realise is the current oil depletion rate from global production as wells dry up.  This is around 400 million barrels a year, yes that’s correct 400 million!  This certainly reduces the projected 3 million peak daily shale production which is still some years off.   With the U.S, the only non OPEC nation increasing production it does not bode well for global supply.

On the demand side, this will more than likely continue to grow, and only pricing in around 1% growth a year globally would leave constraints on global supply in a few years time.

With some basis of support for oil at this current level what opportunities are out there for equities? Well, firstly the energy sector was the worst performing in the S&P 500 over the past two years and since 2009 has underperformed the MSCI world index by 51%.  Companies are forecasting profits based on an oil price of $80, and if it were to remain above $100, one could expect to see significant upside for the share prices.  Also with a large amount of money on the balance sheets for larger companies (read more on this), it is currently cheaper to buy oil via m&a rather than carrying out the exploration yourself and therefore offers further opportunities.

Natural gas is another hot area at the moment, the U.S. has this in full flow providing cheaper costs, however will this be a substitute for oil going forward? Globalisation of LNG may be more apparent as supply side issues in Europe and Asia will be overcome by increasing demand.  Certainly one to keep a close eye on.

So where can you go to take advantage of this? Investec has one of the largest commodity teams managing over $5bn and their Global Energy Fund should provide you with exposure to some excellent companies or Blackrock’s Global Funds World Energy.  This investment theme is one I have in my portfolio and until a fundamental replacement for oil is found, this in my mind is a natural long term fund to hold.