Recent oil prices make for good long-term buying opportunity
Oil prices have been extremely volatile over the past few years as a result of the global financial crisis. The price of a barrel of oil rose to the shocking high of US$140 in the first half of 2008, then plummeted by more than US$100 in subsequent months.
Here is a look at the factors behind oil prices, and what the future may hold.
A bullish viewpoint
While oil prices may be volatile in the short term, the Scotia Capital equity team sees many factors that support oil prices going forward.
As developing economies like China and India expand at a rapid pace, countries that don’t belong to the Organisation for Economic Co-operation and Development (OECD) are expected to begin consuming almost as much oil as developed OECD nations.
Supply slowdown. Underexploration over the past few years, as a result of the financial crisis, has lowered production to the point where inventories will be depleting when the economy recovers. The International Energy Agency estimates that $100 billion of oil production expansion projects were cancelled or postponed. “Bullish longer-term fundamentals are extremely supportive of the underlying commodity price going forward,” notes Geoff Ho, Director and Canadian Equities Specialist for the ScotiaMcLeod Portfolio Advisory Group.
Rising cost of production. There is an increasing need to produce oil in ever-challenging regions and the need for expensive technology. Scotia Capital equity analysts believe the minimum price required for deepwater and oil-sands projects is in the US$75-100 per barrel range. U.S.-dollar weakness. Most commodities, including oil, are priced in U.S. dollars. In recent years, the U.S. currency has fallen dramatically and that weakness is expected to continue as America contends with soaring budget deficits. A weak U.S. dollar means that oil rises in price, which benefits Canadian producers.
Recovery of demand. Crude oil has seen lower demand during the economic downturn, leading to higher inventories, which tends to put a damper on prices. Demand could bounce back more strongly than expected, with production playing catch-up.
Demand shifting away from North America. Ninety per cent of future demand growth for oil will be in Asia, South America, and the Middle East. Consumption in China is expected to rise by 4% in 2010 as car sales surge; currently, just 2% of the population owns a car.
Inflation hedging. Investors flock to commodities when there is a risk of inflation, since the price of raw materials tends to keep pace with inflation. As the global recovery heats up and inflation begins to rise, investors may increasingly turn to oil as an investment,
pushing up prices.
Speculative activity. Over the past two years, we have seen price swings caused by speculation over oil prices, with many investors hoping to cash in on rising oil stocks. Investment funds in commodity markets have risen from an estimated $15 billion to $260 billion since 2003.
Geopolitical risk. Continued and rising tensions in the Middle East may cause prices to rise, since Saudi Arabia is the second-largest supplier of crude oil in the world.
A long-term outlook
The Scotia Capital equity team sees oil as an excellent long-term buying opportunity with price increases supported by strong demand, particularly from Asia. We can help you to determine appropriate exposure to the energy sector for your personal situation and risk tolerance.