Back to Black?
The oil price has been rising over the last few months but is now the time to reconsider portfolio exposure to the black stuff? Brian Tora suggests that advisers ignore it at their peril
Do you include energy as an asset class within your clients’ portfolios? Perhaps it would be more correct to say as a sub-class as most exposure to energy is likely to be gained through investing in energy-related companies. Once energy was all the rage amongst fund managers. When I was an investment manager at a small boutique in the 1970s, our flagship fund was the Jersey Energy Trust, originally launched by Slater Walker, but in the Britannia Arrow stable when I was there.
A few years later I joined Touche Remnant, which was taken over by Henderson shortly after I left to cast my lot in with leading research broker James Capel. Touche Remnant’s principal business was the management of investment trusts and they had launched TR Energy in the early 1980s to deliver exposure to this important sector. Today the emphasis on energy seems altogether lower key, despite the fact that oil has enjoyed something of a resurgence in recent times.
Energy may encompass many varied and different sources, but oil remains the dominant provider of our needs, despite the growth of greener alternatives. And while governments may promote the use of electric cars, for the time being it will be oil that continues to fuel our transport systems. So the behaviour of the oil price will affect both inflationary and economic prospects all around the world. And the price of oil can prove very volatile and is subject to geo-political influences as well as straightforward supply and demand.
That was then
Probably the first time I became fully aware of the importance of the oil price on our financial wellbeing was during the bear market of 1973/4. Following the Yom Kippur war of 1973, the oil price quadrupled and petrol rationing coupons were issued in this country, though they were never actually used. Our benchmark index at the time (the Footsie had yet to be created) fell by around 70% – still the most devastating bear market since the war. True, a banking crisis, political uncertainty and rampant inflation – itself triggered by the rise in the cost of oil products – all contributed, but an oil price rise kicked it off.
Oil returned centre stage in the late 1970s as the Iran/Iraq war created supply disruption and added further uncertainty, leading to a significant hike in the price. The 1980s and 1990s were not without incident, but it was the growth of China as an economic power that drove oil higher, reflecting its rapidly increasing demand for the black stuff. By the summer of 2008 – just a decade ago – the price was nudging $150 a barrel, but the financial crisis that developed in the autumn of that year brought the global economy to a grinding halt, with the result that the oil price collapsed to little more than $30 within six months of its peak.
Supply and demand factors at work
Since then we have had ups and downs. In April 2011 it was back over $100 a barrel, peaking at around $113 in April, but by early 2016 it was back below $30 a barrel – the price at which it is considered uneconomic to even extract it. Last summer it was hovering around $40, but the past year has seen a steady rise, with $80 a barrel being breached twice in May this year. The reason for the resurgence in the price has been complex. Supply has been restricted, with Venezuelan production in decline and a supply cap imposed by OPEC countries. Rumours that this cap was to be lifted removed some of the upward pressure as we moved into summer, but with the IMF concluding that global economic growth should hover around 4% for the current year, demand should remain robust.
Make no mistake, while demand for so-called black gold has declined in relative terms as we become more energy and fuel efficient, it is still in positive territory. The United States leads the consumption tables, using around 19 million of barrels each day, with China second at around 10.5 million barrels. Given that China’s population is around four times that of the US, you can see that its demand is likely to grow as its wealth increases. Similarly, many populous developing nations could well see their consumption of oil grow faster as they improve their economic status.
This is now
So despite attempts to phase out petrol and diesel fuelled cars in the West, it is difficult to see demand for oil doing anything other than grow. Moreover, new sources of oil have, and presumably will, come on stream. Shale oil and gas have been very much in the news in recent years, though I well recall shale oil deposits being cited as important sources back in the 1970s. And the higher the oil price goes, the more likely these deposits are to be developed.
Where do we go from here?
Bear in mind, for every barrel of oil bought for consumption, it is reckoned about ten are traded. Much of the trading will, of course, be oil users hedging their likely needs in order to introduce some certainty into their pricing structures. Airlines are particularly active in this field, but there are plenty of others, as well as those purely interested in playing the market. But short of a global recession, we may not see the oil price back below $50 for the foreseeable future, while concerns over Iran can only maintain upward pressure. Investors ignore oil at their peril.