Media Relations Credit Suisse Asset Management Beaufort House, 15 St. Botolph Street London EC3A 7JJ
For immediate release
Stronger for longer – reasons for today’s high oil price
‘So what are the implications of higher oil prices?’ London, 8 July 2004 - The growth over recent years in the consumption of commodities, driven by Chinese demand and the synchronised global recovery, has led to higher commodity prices across the board. Oil in particular has become headline news, with prices pushing through USD 40 per barrel in May this year. As well as pressure from global demand, the price of oil has been impacted by a lack of spare capacity and subjected to what the Organisation of the Petroleum Exporting Countries (OPEC) President has termed ‘non fundamental factors’ (terror attacks, instability in Iraq, uncertainty in Russia etc), all of which have implications in the longer term for global growth and inflation. Oil production from OPEC fell in 2002 for the second year running in respon se to strong production growth from Russia and non OPEC countries. World oil consumption was also weak at that time, ensuring that the supply/demand dynamics were balanced. The recent surge in demand has been driven by China, which has been a net importer of crude oil since 1993. As emerging economies develop, the global commodity markets benefit: workers in developed economies already own houses, cars and have above subsistence diets so choose to spend income on discretionary goods and services (healthcare, dining out, etc). By contrast, purchase of a house, car or kitchen appliance in emerging economies will impact demand for commodities in the future. With economic growth for 2003 in China and the US at almost 10% and 4% respectively, and non OPEC production unable to respond, the global supply/demand balance for crude oil has been tight. Although OPEC has increased production since 2003, today’s oil price is also supported by a lack of spare capacity and ‘non fundamental factors’. The chart below sho ws how the world’s crude oil system is currently stretched to 98% utilisation. Whilst, there is very limited refining and tanker capacity, storage and delivery capacity have not kept pace with demand, falling from 25 days to 10 days over the last 20 years. This has two significant implications: OPEC (specifically Saudi Arabia, the main producer) has a significant influence over price; and any loss of supply cannot easily be made up, which means the price of crude must be sufficiently high to keep the most expensive crude flowing.
Source: International Energy Agency, US Department of Energy, EIA Adding to capacity concerns, the risk premium within the oil price which is perceived to exist as a result of ‘non fundamental factors’, is increasing volatility. Security of supply is becoming increasingly important, particularly for oil importing countries, as a means of controlling prices. The focus of supply growth has shifted to non OECD countries, with Russia the main beneficiary of OPEC pricing policy and supply constraints. The International Energy Agency estimates that Russia overtook Saudi Arabia in September and November last year as the number one oil producer with Russian production increasing by 11% in 2003. It remains to be seen if Saudi and the other OECD nations will tolerate Russian production growth and if such growth is sustainable with Russia’s infrastructure and political climate. So what are the implications of higher oil prices? Certainly history tells us that a higher oil price leads to higher headline inflation. The trick for central banks is to ensure prices and wages don’t follow suit. In the past it has been disruptions to the supply of oil that has driven prices upwards (most recently in Venezuela and Nigeria). Today, oil prices are driven by a booming global economy, led by America and China, which means that inflationary pressure, and the need for higher interest rates, is greater. Price rises have pushed inflation in the Euro area well above the 2% target set by the ECB (2.5%), while in the US the 12 month inflation rate has jumped from 1.7% to almost 3% in two months, although this is partly due to the fall in the value of the US Dollar. Central banks are considering to what extent interest rates should be raised to kill off the threat of inflation and if this will damage the fragile global recovery. Currently there is concern over the future of Iraq and the new government’s ability to withstand almost daily attacks against either its security force s or oil infrastructure and export the volumes required to keep global growth from stalling
and inflation down. However, the world is not running out of oil and the risk premium is expected to decline as security in Iraq improves and oil companies and gove rnments reach a new level of cooperation on supply security. Global economic growth is forecast to slow in 2005, which will reduce the pressure on the oil infrastructure and allow it to increase spare capacity. However, this takes a long time in comparison to other industries (five – seven years) and the price of oil could therefore feasibly stay above USD 30 per barrel for the next few years. The chart below shows the value of oil companies (excluding dividends) against the price of crude oil from 1974 to date. It illustrates how the underlying price movements of oil can over time be leveraged through owning shares in oil companies provided those firms are able to achieve production and sales volume growth, expand opportunities through new technology and control costs. Over time energy equities have substantially outperformed the oil price
Index, January 1974=100 1,800 Basket of US Integrated Oil Companies ExxonMobil Share Price Crude Oil Price
1,600 1,400 1,200 1,000 800 600 400 200 1974
1980
1986
1992
1998
2004
Source: CSAM, Datastream
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