Black Gold – Oil, OPEC and why it all matters to investors

4th July 2018

“The reports of my death are greatly exaggerated.” – Mark Twain, 1897.

With all the headlines and newspaper column inches being dedicated to renewable energy sources, electric vehicles and (in particular) a certain Mr Musk, we could be forgiven for asking “does oil even matter anymore"? However, contrary to this received wisdom; forecasts from the International Energy Agency (IEA) show global oil demand rising by 1.4 million barrels per day (mb/d) in both 2018 and 2019. Following on from last weekend’s OPEC meeting we will take a quick look at the dynamics of the oil market and how it can filter through to our portfolios.

 

Who is OPEC?
The Organisation of the Petroleum Exporting Countries is effectively a cartel of some of the largest oil producers including; Saudi Arabia, Iran, Qatar, UAE and Nigeria. OPEC is responsible for approximately 40% of global oil production, but (more importantly) account for a substantial majority of the world’s proven reserves of crude.     

OPEC doesn’t exactly play fair. The expressed aim of the organisation is to coordinate and unify the petroleum policies of member nations. Effectively, given the amount of influence these nations have in the oil market they coordinate production in order to manage oil prices. If the market gets "too hot" and prices rise too high the member states will increase production and release more supply on to the market. However, if prices drop too low a coordinated cap on production (as we saw in 2016 and 2017) can help to stabilise the market. In recent years the influence of OPEC has been brought down somewhat by the advent of US Shale Gas – an alternative form of oil production that has transformed the market.

 

US Shale
Shale oil production has been around in theory since the 1940’s but we have only really seen the technological developments needed to make it viable in the last decade. The extraction technique (known as “fracking”) involves pumping a mixture of water, sand and chemicals into loose sedimentary rock formations to release the natural gas trapped there.

The discovery of large quantities of such gas in the USA and increasingly efficient methods of extracting it have led the US to tilt from being a net-importer of oil to a self-sufficient nation. This, in turn, has upset the balance that OPEC seeks to maintain.   

 

OPEC boosts production
Still, at this weekend’s meeting the members of OPEC and proved they continue to have the loudest voice in international energy markets. The ministerial meeting; which also included representatives from the Russian Federation, agreed to an increase in production of 1.8mb/d that should help to avoid a potential deficit between supply and demand over the course of the next year. The move has knocked oil prices today, with the benchmark Brent Crude price down more than 2% at $73.82 per barrel at the time of writing.

 

Why does it matter?
The oil price is one key indicator that we consider when making our asset allocation decisions. We would generally prefer to see a well-balanced market where supply roughly equals demand at a sustainable price. Too high and the oil price will begin to have a negative impact on global GDP growth (as higher costs are passed on to consumers and companies), but too low and there is a negative impact on those countries and companies that produce and supply oil. A low price can feed through to poorer investment in the sector and can cause supply shortages at a later date.

As such, OPEC’s move to stabilise the market is generally positive, but we are conscious that the latest expansion of production may limit readily available spare capacity. Any disruption to supply from a large producer could cause a short-term shortage and lead to a price spike. With geopolitical risks still high in the Middle East, this is something we will be monitoring closely going forward.    

 

For more information on any of the matter raised in this article please contact a member of the Blackadders Wealth Management team. The content of this item is for information only. It does not constitute advice. Before investing in any financial product or service you should seek professional advice.

 Paul Heath, Investment Manager
 Blackadders Wealth Management
 www.blackadderswm.co.uk