Is there still value in oil?

Concerns about geopolitical tensions in the Middle East, particularly in relation to Iran, have helped push Brent crude oil futures higher, reaching a peak in March 2012 of more than $126 a barrel.

While this is significantly lower in dollar terms than the figure of almost $150/bl in the oil bubble of 2008 – when the Brent crude oil price rose sharply to a peak in July before dropping to a low of $38.44 by the end of December – there is a growing consensus that $100/bl is the new equilibrium.

Angelos Damaskos, chief executive of Sector Investment Managers and manager of the £52.2m CF Junior Oils trust, points out that in spite of the eurozone crisis and potential slowdown in the developed world, developing countries such as China, India and other industrialising nations are still driving demand for oil.

“After the crisis of 2008 demand in western Europe, the US and elsewhere dropped significantly but it has now reached a level where the standard of living does not justify much further cuts. Even though private consumers might drive less because petrol prices are rising, we still need oil to power tankers, commercial ships, aircraft, trains and industrial capacity, which means demand becomes quite inelastic to the price of oil.

“It is unlikely demand will soften further in the developed world, whereas the developing world still demands more and more oil. So the demand outlook is constructive and supportive for oil prices, especially given the relative shortage of supply.”

On the supply side, Frances Hudson, investment director and global thematic strategist for Standard Life Investments’ (SLI) multi-asset investing team, points out instability in the Middle East and North Africa (Mena) region is one of the key concerns.

“Of the Opec [Organisation of the Petroleum Exporting Countries] producers, Saudi Arabia is the country with meaningful spare capacity. It is the low cost producer and can vary supply in response to price. Other major producers such as Venezuela and Brazil in Latin America, Russia, China, Nigeria, Algeria, Libya and Iraq all have lots of political considerations.

“After the global financial crisis and economic recession, and the Arab Spring in 2011, the supply dynamics have changed. The prices needed for producers to break even or make a profit increased.”

Mr Damaskos agrees, adding: “Mena is the world’s most prolific producer of oil, so if we have these upsetting factors in that part of the world it can cause short-term supply plunges. For example, if Iran were to start any military action, it could cause a blockage in the Straits of Hormuz that would cause a problem in the transportation of roughly 16 per cent of the daily [oil] consumption of the world and that could spike up prices to crazy levels, perhaps above $200/bl.