Oil: your chance to strike it rich?
By Helen Pridham, Personal Finance correspondent
As the price of crude oil scales new heights, topping $50 a barrel for the first time in New York on Monday night, the immediate cause of the price surge might be different - this time attributed to violence and uncertainty in Nigeria and around the west African oil fields - but the fundamental reason remains the growing imbalance between supply and demand.
The same situation exists in other commodities such as base metals. All this is good news for the natural resources sector, which has performed strongly over the past year.
Future prospects for the sector continue to look extremely promising according to Ian Henderson, the manager of JPMorgan Fleming Natural Resources fund, who says, "We believe we are very early in a multi-year bull market for commodities."
The background to this is many years of underinvestment in mining and exploration coinciding with growing worldwide demand for natural resources, particularly from China, India, and other developing countries.
Even though economic growth in China is expected to slow from more than 10 per cent to around 7 per cent in the next couple of years, this rate of growth is still extremely high by western standards and will still mean a strong demand for commodities and therefore lead to continuing price rises. For instance, oil demand in China is expected to rise by a further 8 per cent next year, reaching 500,000 barrels per day.
Robin Batchelor, an investment manager on the Merrill Lynch World Mining Trust says, "What you see in China is structural change. China wants consumer growth and this means changing patterns of behaviour which is leading to greater and greater demand for energy and raw materials.
For investors, getting a stake in this area provides useful diversification as well as the prospect of attractive returns, says Henry Rising, the head of research at stockbrokers Christows. "We believe you have to look beyond ordinary equities nowadays for returns. With resources there is a real growth story, especially if you look at the industrialisation of China."
This view is echoed by Mick Gilligan, an associate director in fund research at the stockbrokers Killik & Co. "The supply and demand backdrop for energy and commodities is very encouraging. They look quite exciting areas at the moment and not ones you want to be underweight."
A gradual decline in investment in mining and exploration in the last 20 years has lead to a real shortage in commodity stocks. Ian Henderson points out that the stocks of base metals above ground have almost run out. "There has been a complete miscalculation of demand because it was based just on demand from the OECD countries, which only accounts around one-seventh of the world's consumers. Now China has become the biggest importer of everything. Many of the things it was previously exporting, such as coal, oil, steel and zinc, it is now importing to meet its own consumption."
He is surprised that more investors are not taking notice of the sector, especially as there are still plenty of companies on good valuations. "One example is First Quantum, a copper mining company which operates in Zambia which will be producing more than 5 per cent of the world's copper in a year's time. It is on a profits to earnings ratio of less than seven, yet it has tremendous prospects."
Energy is a key investment area for resources funds. Mr Henderson believes there is an "incredible complacency about energy". He says that people who are expecting the oil price to fall back again will have a rude awakening. This year has seen the biggest increase in the demand for oil in history. China alone has upped its demand by 20 per cent over the past year.
Unlike the oil crisis in the 1970s, which was brought about artificially by Opec, this time there have been increases in production by the oil producers' cartel, yet the price of oil has continued to rise. While production in areas such as the North Sea and Alaska are declining in output and traditional oil producing giants such as Saudi Arabia and other Opec states fail to influence the global oil price, it is variations in supplies from Russia, Venezuela and Iraq which has impacted the world oil market, where underinvestment in refinery capabilities - especially in the United States - has had a greater impact on prices.
Mr Batchelor says that the best way to benefit from these trends is through small and medium-sized exploration companies, rather than traditional oil giants such as BP or Shell, where growth potential is limited. The example of Cairn, the Scotland-based company which has seen its share price rise more than 300 per cent this year on the back of exploration finds in India, is the prime example.
Companies operating in relatively underdeveloped areas, such as north and west Africa, can add particular value, says Mr Batchelor.
Coal is another area which Mr Henderson finds interesting at present. "In North America, 52 per cent of energy production comes from coal and most new power stations are coal-fired, but here too there is a shortage of supply."
The shortage of traditional energy supplies is stimulating greater interest in alternative energy. Mr Batchelor, who is also the lead manager on the Merrill Lynch New Energy Technology investment trust, says, "There are signs that things are moving in the right direction. The cost of wind turbines, for example, is falling while the price of coal and natural gas is rising, so traditional energy is getting more expensive while new energy is getting cheaper."
Renewable energy is now the fastest growing part of the energy market but Mr Batchelor admits that the scale is very different to traditional energy suppliers. "It takes time to change people's behaviour patterns but I think as more companies look at their cost base and the price of energy, they will turn increasingly to alternative energy. It won't happen overnight but it will happen slowly but surely over the next few years. In the energy sector, it really is a case of past performance being no guide to the future."
Mr Gilligan agrees. "At some point, alternative energy will be a good investment but it will be difficult to get the timing right. This is probably a classic case in favour of a regular monthly investment in order to ride out the volatility in this market."
The main risk for the energy and resources sector at present is the possibility of a sharp slowdown in global growth, but Mr Henderson points out that the on-going industrialisation of emerging markets will continue to underpin the market. "There may be wobbles along the way, but basically I think the process is unstoppable."
As the price of crude oil scales new heights, topping $50 a barrel for the first time in New York on Monday night, the immediate cause of the price surge might be different - this time attributed to violence and uncertainty in Nigeria and around the west African oil fields - but the fundamental reason remains the growing imbalance between supply and demand.
The same situation exists in other commodities such as base metals. All this is good news for the natural resources sector, which has performed strongly over the past year.
Future prospects for the sector continue to look extremely promising according to Ian Henderson, the manager of JPMorgan Fleming Natural Resources fund, who says, "We believe we are very early in a multi-year bull market for commodities."
The background to this is many years of underinvestment in mining and exploration coinciding with growing worldwide demand for natural resources, particularly from China, India, and other developing countries.
Even though economic growth in China is expected to slow from more than 10 per cent to around 7 per cent in the next couple of years, this rate of growth is still extremely high by western standards and will still mean a strong demand for commodities and therefore lead to continuing price rises. For instance, oil demand in China is expected to rise by a further 8 per cent next year, reaching 500,000 barrels per day.
Robin Batchelor, an investment manager on the Merrill Lynch World Mining Trust says, "What you see in China is structural change. China wants consumer growth and this means changing patterns of behaviour which is leading to greater and greater demand for energy and raw materials.
For investors, getting a stake in this area provides useful diversification as well as the prospect of attractive returns, says Henry Rising, the head of research at stockbrokers Christows. "We believe you have to look beyond ordinary equities nowadays for returns. With resources there is a real growth story, especially if you look at the industrialisation of China."
This view is echoed by Mick Gilligan, an associate director in fund research at the stockbrokers Killik & Co. "The supply and demand backdrop for energy and commodities is very encouraging. They look quite exciting areas at the moment and not ones you want to be underweight."
A gradual decline in investment in mining and exploration in the last 20 years has lead to a real shortage in commodity stocks. Ian Henderson points out that the stocks of base metals above ground have almost run out. "There has been a complete miscalculation of demand because it was based just on demand from the OECD countries, which only accounts around one-seventh of the world's consumers. Now China has become the biggest importer of everything. Many of the things it was previously exporting, such as coal, oil, steel and zinc, it is now importing to meet its own consumption."
He is surprised that more investors are not taking notice of the sector, especially as there are still plenty of companies on good valuations. "One example is First Quantum, a copper mining company which operates in Zambia which will be producing more than 5 per cent of the world's copper in a year's time. It is on a profits to earnings ratio of less than seven, yet it has tremendous prospects."
Energy is a key investment area for resources funds. Mr Henderson believes there is an "incredible complacency about energy". He says that people who are expecting the oil price to fall back again will have a rude awakening. This year has seen the biggest increase in the demand for oil in history. China alone has upped its demand by 20 per cent over the past year.
Unlike the oil crisis in the 1970s, which was brought about artificially by Opec, this time there have been increases in production by the oil producers' cartel, yet the price of oil has continued to rise. While production in areas such as the North Sea and Alaska are declining in output and traditional oil producing giants such as Saudi Arabia and other Opec states fail to influence the global oil price, it is variations in supplies from Russia, Venezuela and Iraq which has impacted the world oil market, where underinvestment in refinery capabilities - especially in the United States - has had a greater impact on prices.
Mr Batchelor says that the best way to benefit from these trends is through small and medium-sized exploration companies, rather than traditional oil giants such as BP or Shell, where growth potential is limited. The example of Cairn, the Scotland-based company which has seen its share price rise more than 300 per cent this year on the back of exploration finds in India, is the prime example.
Companies operating in relatively underdeveloped areas, such as north and west Africa, can add particular value, says Mr Batchelor.
Coal is another area which Mr Henderson finds interesting at present. "In North America, 52 per cent of energy production comes from coal and most new power stations are coal-fired, but here too there is a shortage of supply."
The shortage of traditional energy supplies is stimulating greater interest in alternative energy. Mr Batchelor, who is also the lead manager on the Merrill Lynch New Energy Technology investment trust, says, "There are signs that things are moving in the right direction. The cost of wind turbines, for example, is falling while the price of coal and natural gas is rising, so traditional energy is getting more expensive while new energy is getting cheaper."
Renewable energy is now the fastest growing part of the energy market but Mr Batchelor admits that the scale is very different to traditional energy suppliers. "It takes time to change people's behaviour patterns but I think as more companies look at their cost base and the price of energy, they will turn increasingly to alternative energy. It won't happen overnight but it will happen slowly but surely over the next few years. In the energy sector, it really is a case of past performance being no guide to the future."
Mr Gilligan agrees. "At some point, alternative energy will be a good investment but it will be difficult to get the timing right. This is probably a classic case in favour of a regular monthly investment in order to ride out the volatility in this market."
The main risk for the energy and resources sector at present is the possibility of a sharp slowdown in global growth, but Mr Henderson points out that the on-going industrialisation of emerging markets will continue to underpin the market. "There may be wobbles along the way, but basically I think the process is unstoppable."
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