Secular bull markets are relatively rare, often only identified afterwards. But there can be few modern examples as certain as the one taking place in the oil sector. There is growing evidence of a long-term imbalance in supply and demand for oil and, though there will be short-term fluctuations, these will merely offer excellent buying opportunities.This is not to say that oil has not seen some deep bear markets in the past. In the 1980s a fall from a $100 peak to $20 in today’s prices decimated the American oil industry. There was renewed hope in the mid-1990s, but the Asian financial crisis stemmed demand in the world’s fastest-growing economy. Now the Far East’s economic growth is back on track, increasing demand within global commodity markets. The inexorable rise in demand for oil is a compelling argument and is likely to remain so for the next 10 or 20 years. Oil consumption in developing countries, led by China and India, continues to grow rapidly, with massive potential for further growth. These countries still consume only a fraction of the oil per head used in the West. But China is already the world’s second-largest oil importer after America. Even if China were to experience the hard economic landing forecast by some, it would probably result in no more than a temporary slowing in the rate of increasing demand for energy. Nor would recessions in America or several European countries in the next few years be likely to prompt a significant decline in energy consumption. Humanity’s ability to use energy more efficiently has not reduced our overall demand for oil. The reason is that we continue to find more uses for energy. The sheer variety of “indispensable” gadgets that we own today, relative to 20 years ago, points to this. There are, of course, alternative energy sources, and higher oil prices can only increase demand for them. While natural gas and coal are credible alternatives, there are issues over their availability and extraction costs. Nuclear energy, considered the energy panacea in the 1950s, brings its own raft of environmental problems. Despite recent spot prices exceeding $50 a barrel, oil remains relatively competitive when considered against alternative energy sources. For this reason battery and hydrogen-powered cars are likely to remain niche products for some time to come. On the supply side, the story is equally supportive for oil. Clearly, the oil supply is finite. The argument that there may be 40 years or more of oil reserves left misses the point. The proportion of oil left from the original reserves is more relevant. A well-known former Shell geologist, M King Hubbert, correctly predicted in 1956 that the rate of American oil production would peak in 1970. His theory postulated that when half an oil reserve is gone, the marginal cost of production rises sharply, making actual increases in output extremely difficult. Given that on most consensus estimates the earth originally had about 2.2 trillion barrels of recoverable oil and that an estimated 1.1-1.25 trillion has already been drilled, the crucial halfway point may already have been reached. The fact is that despite more efficient extraction technology, limited supply is likely to become an increasing problem. Even if more reserves were discovered, it is unlikely they would stave off the problem of dwindling supplies for more than a few years. Charles T Maxwell, a senior analyst at Weeden & Co in Greenwich, Connecticut, who has been working in the field for 36 years, pointed out in an article in Barrons last November that few people outside the oil industry understand that 6-7% more oil reserves must be found and made available to the market each year to meet a 2% growth in world consumption. This is because some 4-5% of world crude production is depleted each year. This is a colossal task and it gets harder as the potential reserve size of prospects being drilled is smaller and the large fields found in the past are depleted. At present, some 70% of the oil consumed comes from fields discovered a quarter of a century or so ago. Nor must the strain on the industry’s ability to refine oil be forgotten. The industry is suffering from many years of under-investment. The failure of the Organisation of Petroleum Exporting Countries, mainly Saudi Arabia, to raise output earlier this year in the face of oil price spikes because of constraints on its refining capacity is testament to this. Maxwell said in his article that the world is no longer investing enough to lift capacity above the level of future demand growth. The developments currently under way in the oil industry’s laboratories are insufficient to raise capacity enough. While the ups and downs in the oil price over the years might encourage investors to think oil shares should be traded, there is a long-term upward trend that backs the argument for holding on to shares. Many funds have exposure to oil in one way or another, but the most notable include Investec GSF Global Energy and its recently launched onshore equivalent – the Investec Global Energy fund. Others include JPMF Natural Resources, First State Global Resources and the Merrill Lynch New Energy Fund. All have exposure to oil, but the purest play of all, and the one we use, is the Investec GSF Global Energy fund. The Investec funds hold about 20-30 stocks with a buy-and-hold strategy. Manager Tim Guinness believes stock-specific risk can be eliminated with more than 20 stocks in a sector, while anything between 25 and 50 is in danger of hampering the chances of outperforming. He screens 150 stocks, most with market capitalisations of more than $1bn (576m). The bullish long-term case for oil is certainly not a new story. Many will be familiar with supply inelasticity and increasing demand for industrial raw materials. Consequently, the resources sector ran ahead of itself in 2004 and the first quarter of this year. In our view, a correction in the oil price is under way that could bring it close to $40 from the current high of above $60 per barrel. Equally, optimism for the energy sector is extremely high – often a contrarian sign. Therefore, I am hoping for a better buying opportunity for the energy sector later in the cycle. But if you are bullish and looking to buy, a well-managed energy fund certainly merits consideration.
The inexorable rise in demand for oil, fuelled by the Far East, combined with depleting stocks point to excellent buying opportunities for funds investing in the natural resources sector.