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Daily Global Strategy Note
WEDNESDAY, FEBRUARY 23, 2011
In this issue:
What happens if oil shoots up to $130 per barrel?
Energy prices: What happens if oil
goes to $130/barrel? Who would be
most affected, what would it mean
for the recovery and how should
investors hedge against this? We
think that emerging economies are
most vulnerable to a rise in oil prices.
In our view, a 30% rise in oil prices
would slow down the recovery in
developed economies, without killing
it altogether. Finally, we believe that
remaining overweight Energy is the
best way to hedge against this
outcome.
Unrest in the Middle East and North Africa is pushing oil prices up significantly.
Moammar Gadhafi's vow to violently crack down on protesters and to fight until
"his last drop of blood" sent WTI up about 6% yesterday.
Sharp rise in oil prices
WTI price in today's U.S. dollars
USD/barrel (log scale)
100
50
20
Beware of global E&P companies
with large oil operations in the
Middle East and North Africa. Over
the past few days, the stocks of ENI
SpA and OMV AG have been under
pressure due to their high exposure
to the region. But these are not the
only companies which get a
significant portion of their oil
production in the Middle East or
North Africa. We have screened for
S&P Global 1200 E&P and Integrated
companies that have large oil
operations in those two regions.
C-EN-00042
10
57
61
65
69
73
77
81
85
89
93
97
01
05
09
Brockhouse Cooper (data via Datastream)
Shaded areas = U.S. recessions
Clearly, if unrest spreads to other countries in the region – including all-important
Saudi Arabia, or Iran – oil prices will be in for a shock. We have been positive on oil
prices for some time, not because we expected a wave of Middle Eastern unrest,
but rather because we saw the global economic recovery as well as supply and
demand fundamentals more consistent with a barrel at $100 than at $75.
But what will happen if oil shoots up to $130 on further Middle Eastern and North
African unrest? Specifically, the questions on investors' minds are: 1) who would
be most affected by such a rise; 2) what would it mean for the economic recovery;
and 3) how should one hedge against this scenario?
Firstly, we note that emerging economies would be, on the whole, more affected
than developed countries by a precipitous rise in oil prices. Energy intensity, as
calculated by the World Bank and defined as kilograms of oil used per $1,000 of
real GDP per capita on a PPP basis, is in general higher in emerging countries than
in developed countries. In emerging economies, more energy-intensive production
processes often stem from reliance on inefficient, outdated energy facilities.
Weather issues can also affect energy intensity.
Pierre Lapointe
Global Macro Strategist
[email protected]
Alex Bellefleur
In terms of energy intensity, emerging Asian countries come to mind first. China,
Vietnam, Malaysia and India are four countries with the highest energy intensities.
In the event of an oil price spike, they would be among the most affected. Overall,
European countries tend to have fairly low energy intensities, probably due in part
to relatively high taxes on fuel, which, over time, have reduced these countries'
reliance on energy-inefficient processes.
Financial Economist
[email protected]
514-932-7171
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Daily Global Strategy Note
WEDNESDAY, FEBRUARY 23, 2011
Emerging economies most at risk of oil price spike
Energy intensity: Kilogram of oil equivalent use per $1,000 of GDP per capita (2005 PPP), 2007
SOUTH AFRICA
CHINA
VIETNAM
CANADA
MALAYSIA
FINLAND
INDIA
CZECH REPUBLIC
WORLD
KOREA
UNITED STATES
AUSTRALIA
POLAND
BELGIUM
SWEDEN
NEW ZEALAND
HUNGARY
PHILIPPINES
BRAZIL
FRANCE
NETHERLANDS
MEXICO
JAPAN
JAPAN
EURO AREA
GERMANY
SINGAPORE
NORWAY
TURKEY
AUSTRIA
SPAIN
PORTUGAL
GREECE
ITALY
DENMARK
UNITED KINGDOM
SWITZERLAND
IRELAND
HONG KONG
0
50
100
150
200
250
300
350
Brockhouse Cooper (World Bank data via Datastream)
Secondly, what would a 30% spike in oil prices mean for the recovery? We believe
the impact would be twofold. The increase in the price of oil would affect industrial
production as well as private consumption.
On the industrial production cycle, we estimate that holding everything else
constant (i.e. interest rates, changes in inventories and prior industrial production
numbers), a 30% increase in oil prices would reduce industrial production growth
by about 0.2% on a quarterly basis in the U.S., or roughly 0.8-1.0% on an
annualized basis. Industrial production is currently growing at about 5% on a yearover-year basis in the U.S. and has represented one aspect of the recovery that
has been quite strong. We expect the industrial production cycle to gradually move
from recovery to expansion, which would entail a modest slowdown. A 30% rise in
oil prices, in our opinion, would not entirely kill this sector's momentum, but would
slow it down.
What about the U.S. consumer, who is barely starting to recover? Our model
considers the impact of oil prices, housing values, equity prices, interest rates and
the unemployment rate as determinants of personal consumption expenditure
growth. Ceteris paribus, we estimate that a 30% increase in oil prices would
translate roughly into a slowdown of 0.1% for growth in personal consumption
expenditures on a quarterly basis (i.e. about 0.5% on an annualized basis).
However, the slowdown would likely not be immediate, as higher oil prices take
time to work their way through the economy to affect consumer behaviour.
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Daily Global Strategy Note
WEDNESDAY, FEBRUARY 23, 2011
Overall, the impact of higher prices on the U.S. and on most developed countries
would be negative, but would not send economies back into recession. Despite
the U.S.'s addiction to oil and relatively low taxes on gasoline, we note that energy
intensity has been steadily improving over the past several years, to the extent that
intensity is about half of what it was in 1973.
Energy intensity of U.S. economy about half what it was in 1973
Energy intensity
Consumption, thousand BT U per real dollar of GDP
14
12
10
8
7.4
6
Energy intensity - oil & natgas
Energy intensity - total
73 75
77 79 81 83
85 87 89 91 93
E-US-00267 4.5
95 97 99 01
03 05 07 09
Brockhouse Cooper (EIA data via Datastream)
Shaded areas = U.S. recessions
Therefore, a repeat of 1973 seems unlikely. Moreover, there is the issue of
magnitude; in 1973, prices (in today's dollars) had increased by more than 100%.
An increase in oil prices to more than $210 is not on the table for now, barring
some serious contagion in Saudi Arabia. A repeat of 2008 (where inordinately high
oil prices had exacerbated the recession) also seems unlikely, since the economy
was already mired in a deep recession back then – a situation that is different from
today.
Nevertheless, how should investors hedge against a worsening of the Middle
Eastern situation and significant increases in oil price?
Firstly, we believe that investors should stay overweight Energy. If oil prices spike,
this will result in a transfer of wealth from energy consumers to energy producers
– and this will benefit companies in the Energy sector. On the other hand, if the
situation calms down and oil prices retreat from current levels, the Energy sector
remains profitable and attractively valued. Moreover, all risk assets would benefit
under the second scenario – including the Energy sector. In this context, we
reiterate our overweight recommendation on the Energy sector.
Investors will want to be invested in countries whose equity markets are exposed
to the Energy sector, but whose economies are not overly energy-intensive. In
other words, we would recommend to favour investments in countries whose
equity markets can reap the benefits of rising energy prices and whose economies
would not suffer unduly from higher oil prices. Norway, whose stock market
Energy weight exceeds 50% and whose energy intensity is relatively low, comes
to mind. At the other end of the spectrum, South Africa and China are more
problematic. For Chinese policymakers, this rise in oil prices represents yet another
headache, amid monetary tightening, concerns over real estate valuations, banks'
capitalization and local government loans gone bad. This situation will further
complicate the tough balancing act currently facing Chinese policymakers, as it
increases the risk of policy overkill.
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Daily Global Strategy Note
WEDNESDAY, FEBRUARY 23, 2011
Norway in good position to weather precipitous rise in oil prices
Kilograms of oil equivalent use per $1,000 of GDP per capita (2005 PPP), 2007
RUSSIA
Bad
SOUTH AFRICA
250
CHINA
CANADA
Energy intensity
200
FINLAND
INDIA
CZECH REP.
KOREA
Good
AUSTRALIA
BELGIUM
150
POLAND
US
SWEDEN
NEW ZEALAND
HUNGARY
FRANCE
BRAZIL
NETHERLANDS
MEXICO
JAPAN
GERMANY
DENMARK
SINGAPORE
TURKEY
NORWAY
AUSTRIA
SPAIN
PORTUGAL
GREECE
100
UK
SWITZERLAND
ITALY
IRELAND
HONG KONG
50
DN20110223A Energy intensity 2
%
0
10
20
30
40
50
Weight in Energy sector
Brockhouse Cooper (MSCI, IGA data via Datastream)
Bottom line: The best way to face current risks of higher energy prices is to
remain overweight the Energy sector. Significantly (30%+) higher oil prices would
represent a headwind to the recovery in developed economies, but would not kill it
altogether. We are maintaining our overweight recommendation on global equities
(although we reduced our equity allocation by five percentage points last week,
from 70% to a still-overweight 65%). We are also concerned that investors who
sent the 10-year U.S. Treasury yield lower by about 15 basis points yesterday on a
massive "risk-off" move may have overlooked the inflationary impact of higher oil
prices down the road. This leads us to remain underweight bonds.
Beware of global E&P companies with large oil
operations in the Middle East and North Africa
Global demand for oil products is on a clear uptrend. And, as we showed in
yesterdays' Daily Note, it might be challenging for OPEC members to increase the
supply to control the increase in oil prices. As a result, the upward pressure on oil
prices has grabbed the attention of investors. There is marked interest in the
commodity, but also in energy equities. Which energy industries are better
positioned to participate in the oil rally?
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Daily Global Strategy Note
WEDNESDAY, FEBRUARY 23, 2011
During the 2007-08 oil boom, Exploration and Production as well as Oil Equipment
& Services were the best way to play the story. Integrated companies, which are
considered as more defensive, lagged the other two industries. Once energy
prices started to turn south in the summer of 2008, Oil Equipment & Services
registered the biggest decline of all industries.
E&P and Oil Services outperform Integrateds in commodity spikes
Datastream World E&P, Oil Services, Integrateds vs. WTI
Index, Jan. 2007=100
Exploration & production
Integrated Oil & Gas
Oil Equipment & Services
WTI
200
153
144
150
126
101
100
50
C-EN-00043
07
08
Brockhouse Cooper (data via Datastream)
Shaded areas = U.S. recessions
09
10
11
Within the Exploration and Production industry, we would avoid companies which
get some of their production from the Middle East or North African region. Over
the past few days, the stocks of ENI SpA and OMV AG have been under pressure
due to their high exposure to the region. But these are not the only companies
which get a significant portion of their oil production in the Middle East or North
Africa. We have screened for S&P Global 1200 E&P and Integrated companies that
have large oil operations in those two regions. We did not consider natural gas
production for this exercise.
Energy companies with large percentage of their oil produciton coming from the Middle East and North Africa
Name
Ticker
Country
Industry
% of oil production coming from the Middle East and North Africa
Total SA
FP FP
France
Integrated Oil & Gas
68.0%
Tullow Oil PLC
TLW LN Britain
Oil & Gas E&P
61.7%
ENI SpA
ENI IM
Italy
Integrated Oil & Gas
60.0%
BP PLC
BP/ LN
Britain
Integrated Oil & Gas
46.4%
Occidental Petroleum Corp OXY UN United States
Integrated Oil & Gas
41.2%
Hess Corp
HES UN
United States
Integrated Oil & Gas
39.1%
Marathon Oil Corp
MRO UN United States
Integrated Oil & Gas
33.9%
Apache Corp
APA UN United States
Oil & Gas E&P
30.7%
Anadarko Petroleum Corp APC UN United States
Oil & Gas E&P
27.4%
Exxon Mobil Corp
XOM UN United States
Integrated Oil & Gas
25.9%
OMV AG
OMV AV Austria
Integrated Oil & Gas
25.2%
Chevron Corp
CVX UN United States
Integrated Oil & Gas
22.4%
Noble Energy Inc
NBL UN United States
Oil & Gas E&P
19.7%
Pioneer Natural Resources CPXD UN United States
Oil & Gas E&P
19.1%
Royal Dutch Shell PLC
RDSA LN Netherlands
Integrated Oil & Gas
18.0%
Royal Dutch Shell PLC
RDSB LN Netherlands
Integrated Oil & Gas
18.0%
Nexen Inc
NXY CT
Canada
Oil & Gas E&P
12.9%
Suncor Energy Inc
SU CT
Canada
Integrated Oil & Gas
9.6%
Pierre Lapointe
Alex Bellefleur
5