Commodities: Barrels of choice for investors

With sovereign defaults looming and a slowdown on the cards for China, forecasters are falling over themselves to predict a strong downturn in global growth.

Against that backdrop investors might have expected to see the spot – or cash – price of a commodity like Brent crude oil fall in the same way as the FTSE 100, falling by almost 8.8 per cent between the start of July and the end of November. It did not.

In fact, in the five months from July to November when the FTSE made that fall of almost 9 per cent, the spot price of Brent crude rose by close to 4.4 per cent. Even if UK investors strip out currency considerations and consider the price of Brent crude in dollars, the movement remains a positive one.

This fact underlines the value to investors of holding commodities alongside equities. They can smooth out volatility in a portfolio and offer positive returns when stock markets are falling.

Libyan factor

One of the factors that drove the Brent crude price up was the loss of Libyan oil from the market during the fighting to depose the Gaddafi regime. It was a simple question of constrained supply pushing up prices.

Before the conflict Libya was producing

roughly 1.6m barrels of high-quality crude oil a day, most of which went to European refiners.

When fighting cut off supplies from Libya it was no surprise that the price of Brent crude began to rise. In fact it went on to command a significant premium over the other major oil price benchmark, West Texas Intermediate. At one point the price difference was as high as $24 a barrel, a remarkable figure given how closely the two benchmarks have tracked each other for years.

The difference in price can be attributed to a number of factors. Brent crude is extracted from beneath the North Sea and is thus better placed geographically for European markets. There has been a glut at West Texas Intermediate’s delivery point at Cushing in Oklahoma, where the operation has also been affected by logistical issues.

So can we expect to see the price of Brent crude fall as Libyan production comes back on stream and the much talked about slowdown in European economies starts to have an impact? The answer to this is quite possibly no.

Japan has a much increased requirement for oil-based energy given that a large part of its nuclear generating capacity is offline and likely to remain so in the peak demand months of December 2011 through to March 2012. This leaves a large energy shortfall that can only be filled by much increased use of oil-powered electricity generation.

Looking beyond that, not only is there continued civil unrest in many Arab states, but more importantly there is also the increased isolation of Iran, one of the major oil-producing states. Only Saudi Arabia and Russia exported more oil than Iran in 2010.