Specialist investment manager Investec Asset Management believes that with political contagion risks spreading across north Africa and the Middle East, the “guarantee of crude supply” could be further affected, leading to a possible spike in the oil price to more than US$150 per barrel.
Mark Lacey, Investec Global Energy Fund co-portfolio manager, questioned whether the current prices of $111 per barrel reflected a crisis? “In our view, current prices do not reflect a crisis. Our price forecasts based on the long-term cost dynamics of the industry remain unchanged - we continue to assume prices of $100 per barrel in our company models. Large-scale projects in Canada and satellite projects in the North Sea, for example, need $100 per barrel in order to make a 10% cost of capital return.”
Investec said that, while indications suggested further political deteriorations in Libya, the destabilisation of Bahrain could be potentially more damaging still. “Potentially, unrest in Bahrain, home to the US Fifth Fleet and connected to Saudi Arabia by the King Fahd causeway, carries with it political implications for strained relations with both Iran and Saudi Arabia.
“While unrest is still at an early stage, 'guarantee of crude supply' could be further impacted, and we believe it is feasible for the oil price to spike upward over $150 per barrel,” Lacey said.
Looking at supply/demand fundamentals and setting political uncertainty aside, Investec said that the current balance was marginally better than in 2008; spare capacity of oil cartel OPEC's 12 members was close to 4.5 million barrels per day (mb/d) compared with just under 2mb/d in 2008.
“However, whether there is 5.0% spare capacity or around 2.2% spare capacity - this still points to a tight market,” Lacey said.
“The key issue centres on a lack of industry investment in new projects in recent years, which is likely to have an impact on future supply. The global recession put mega-project awards in offshore west and north Africa, Mexico and the Middle East on hold, which has meant that, apart from Brazil, large-scale incremental supply will be limited over the next few years. Over the past three years, the industry has again underinvested and this will have an impact on the flexibility of supply growth over the next few years,” he added.
In addition, following the Macondo well disaster in the Gulf of Mexico, Investec also noted a drilling moratorium on future deepwater drilling in the US Gulf of Mexico.
It highlighted producing countries potentially at risk of production shut-ins including Libya (1.6mb/d), Algeria (1.2mb/d), Egypt (1.0mb/d) and Iran (3.7mb/d). These equated to roughly 8.5% of total crude supply. Investec stressed, however, that not all production was at risk.
“Some production is being shut-in, given that the first priority of international oil companies is the safety of their staff,” Investec said.
Impact of crude price at $150 per barrel on global economy?
“Early this year, we pointed to the risk of a crude price spike stemming from another strong demand growth period between 2010 and 2013 effectively removing spare capacity. However, the negative impact on demand of rising prices has to be taken into consideration. While demand has not yet been negatively impacted by price, prices in excess of $100 per barrel are negatively viewed by many global leaders, impacting both the consumer 'energy burden' and posing a significant threat to the much needed OECD economic recovery,” Lacey said.
In addition, avoiding a spike in crude prices was in the interests of OPEC members, who needed large OECD consumers to recover from the recent recession. “Looking back, the oil shock of 1979-80 resulted in expenditure on oil as a percentage of GDP doubling to 8% from 4%, resulting in a significant fall-off in OECD demand over the following few years as a global recession took place,” Investec said.
It pointed out that, at about $80 per barrel of oil, current nominal oil expenditures as a percentage of GDP still stood at about 4%, supporting the view that $90-$100 per barrel could be “absorbed” within global GDP. “While in the short term a crude price spike towards $150 per barrel is not inconceivable, we would expect a potential price spike to be met given that OPEC's spare capacity is greater than in 2008 and key OPEC members should increase oil shipments to calm the market. Indeed on Tuesday, the Saudi oil minister, Ali Naimi, stated that Saudi Arabia's oil production capacity is 12.5mb/d, a level that can help 'compensate for any shortage in international supplies',” Lacey said.
Current value at present
Investec questioned whether companies exposed to large-scale crude resources in politically stable areas offered good value.
“Yes definitely, but it is important to note that we are unlikely to increase our long-term oil price forecast of $100 per barrel as a result of these political events - this forecast has always been based on costs and it is impossible to forecast political risk,” offered Lacey.
“However it is worth noting that two companies that we hold have significantly underperformed the crude price appreciation in recent months. Both Petrobras in Brazil and Nexen in Canada have deep resource lives, are in politically stable areas and have the ability to grow volumes organically for the next 10 years.
“Based on our estimates we see these companies' sum of parts valuation offering over 55% upside from current levels, assuming $100 per barrel long term,” he concluded. - I-Net Bridge