I have published articles over the last few months in the Journal to help investors understand what the global economic drivers will be over the next ten years. The three drivers were:
- Growth of the world population
- Global debt
- Monetary easing and inflation
In our long-term investment themes to generate wealth over the next ten years, we have debated the relevance of including the energy sector and in particular, the oil sector as a theme. Healthcare and technology are obvious growth sectors for the years to come, but what about oil? Will fracking bring so much supply that it will negatively affect price in the future? Can natural gas replace some of the demand? Are oil producers a long-term investment or should they be traded?
World oil demand has grown considerably in the past decade, rising from about 76 million barrels per day (mbpd) in 1999 to around 90 mbpd to date. Increase in world population should translate into economic growth. This should require an increase in the quantity of energy needed to power cars, trucks, trains and planes to transport people and goods around the planet. However, demand may not continue to increase at the same rhythm we experienced in the past.
First, technology continues to produce engines requiring less fuel. At the same time, natural gas and electricity are gradually taking market share away from the traditional gasoline- powered vehicle. According to Seth Kleinman, head of energy strategy at Citigroup, cheaper substitutes and improvements in fuel efficiency will reduce demand growth and bring lower oil prices going forward. He is predicting that Brent prices will range between US$80-$90 a barrel at the end of the decade. Second, the accounting firm PWC calculates that shale oil production could reach up to 14 million barrels a day (ten times its present level) as more discoveries are made worldwide. This would send oil prices tumbling by 25 to 40 percent.
If Kleinman and PwC are right, this would mean that the growth in the oil sector will be limited, to say the least, over the next ten years. This would also be bullish for the economy, as a drop in the price of gasoline would translate into an increase in consumer discretionary spending. We should note that we would be surprised to see the price of oil drop below $70 going forward as break-even points for fracking and oil sands extraction hover around $60 per barrel.
How to profit from the sector
If oil producers are losing their appeal as a buy and hold, does that mean they have no room within your portfolio?
Not necessarily. We like to say that oil price is its own worst enemy. Buy oil companies when the price of oil is in the 70s and be patient. As the price of oil increases and passes the $90 dollar mark, put a stop loss at a 10 percent profit on your position. Move the stop loss higher as the price continues to increase. When prices move north of $100, gasoline at the pump will reach a point where U.S. consumers will start to reduce their spending, contracting the economy and sending the price of oil lower.
This should trigger your stop loss and leave you with an interesting profit. Wait and repeat.
In a matter of fact, gasoline prices can be used as a leading indicator of the U.S. economy. As the price at the pump increases and continues to stay high for a few months, U.S. consumers reduce their spending, and this weakens the economy.
The graph clearly illustrates that an important increase in gasoline prices is usually followed by a recession.
Some will argue that it is not the price of gasoline but the monetary policy that would be responsible for the price at the pump and the recession. This is all simply semantics.
What we need to know is that an increase in the price of gasoline is usually followed by an economic slowdown. Therefore, be careful out there, as gasoline prices are getting close to an historical high.
Conclusion: Don’t buy and hold oil or oil related stocks. Trade them.