Are Oil Prices On The Increase Again?

05.05.10

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Consumer price inflation rose sharply between February and March in the Eurozone and UK. In Europe, year-on-year inflation increased from 0.9% to 1.4% and in the UK from 3% to 3.4%. In both case

Consumer price inflation rose sharply between February and March in the Eurozone and UK. In Europe, year-on-year inflation increased from 0.9% to 1.4% and in the UK from 3% to 3.4%. In both cases it was higher than economists had expected. The key culprit was fuel costs, with transport inflation at 11.3% in the UK and 6.1% in the Eurozone. Not only may oil prices increase, but with oil traded in US Dollars we could suffer even higher prices locally if the Dollar strengthens against the Euro and Sterling.

Crude oil hit an 18 month high of $87 a barrel on 6th April ? could it reach triple figures again? Oil first hit $100 a barrel in January 2008. It went on to hit a peak of $147 on 11th July before collapsing right down to $32 in December 2008 as the global recession triggered a contraction in global oil demand.

Between last September and March oil traded mainly within the $70 and $80 range, which suited oil producers without too much of an adverse effect on consumers. However, increasing confidence in the global economic recovery caused prices to rise in April. Concerns over the financial situation in Greece did then scale them back a little, but what can we expect ahead?

According to technical analysts at Barclays Capital, overall US demand is improving, laying the foundations for a broad-based recovery not withstanding the weakness in Europe. Oil prices are on course to move higher, possibly to $94 a barrel this year.

Predictions for next year include $100 from Morgan Stanley and $110 from Goldman Sachs.

The underlying issue of supply and demand will be a major factor in future oil prices. Demand plummeted during the global economic downturn, but as that is reversed demand is picking up again and will continue to do so. As demand increases, the price could increase as well.

In mid April the International Energy Agency (IEA) revised consumption estimates upwards and said that global oil demand will hit a record high this year. While consumption in Europe still looks weak, there are signs that demand is picking up in North America, the Pacific, Asia and the Middle East.

The IEA said that in the second quarter of 2010 refineries around the world will process nearly 1 more million barrels per day than they did in the same period last year ? with China and Asian countries raising output the most.

This demand means that the price of oil is unlikely to drop significantly. The IEA has warned that economic growth could be stifled if prices rise too far, but this does not necessarily mean that the price will not continue to rise.

With strong demand from Asia and China already helping sustain oil prices, what will happen when US demand increases and when the European economy recovers?

Another ?supply and demand? issue that may affect the price of oil is the quantity of oil reserves available. According to research by Oxford University and the Smith School of Enterprise and Environment (whose Director, David King, was the government?s former chief scientist), capacity to meet projected future oil demand is at ?tipping point?. The report says that the age of cheap oil has ended as demand starts to outstrip supply as we head towards the middle of this decade. It also suggests that the current oil reserve estimates should be downgraded since official figures are inflated.

The currency issue

Taking the 6th April peak of $87 a barrel, this is still $60 cheaper than the $147 we saw in mid 2008. However the price at the petrol pump for consumers in the UK and Europe tells a different story.

Oil is traded in US Dollars. In the UK, Sterling?s weakness has meant that British importers (and therefore consumers) are paying more for oil. In US Dollar terms, the price of oil was 41% lower on 6th April 2010 than it was on 11th July 2008. In UK Sterling terms, however, it is only 23% cheaper. If the price of oil increases, and/or the Dollar continues to strengthen against the Pound (as it may well do as confidence in the US economic recovery continues), the price of oil is going to inch up.

In Euro terms, oil is currently around 31% lower than it was in July 2008. If the well documented financial problems in the Eurozone persist and the Euro continues to weaken, the price of oil in the Eurozone will increase.

The cost of oil hits us all. We are affected directly in the form of petrol and energy costs and indirectly if manufacturers have to put their prices up to compensate for higher production and transportation costs.

As with all tradable assets, it is hard to predict future price movements with any certainty. This time next year we may see oil at a similar price to today, or perhaps at a lower price, or then again it may be trading regularly above $100. Just as the expansion of Asian countries could push up the price of oil, it could also push up other key commodities, potentially triggering higher inflation for us all.

When it comes to protecting your wealth from the long-term effects of inflation, it is possible to take advantage of global trends like the rise of Asia and the world?s increasing consumption of commodities. Commodities tend to increase in price in years when inflation rises and can therefore be a useful component of your portfolio. Along with other real ? ?tangible? – assets like equities and property they can provide an effective hedge against cost of living rises. However, you should always obtain advice in line with your risk tolerance and investment objectives.

Speak to an experienced and authorised financial adviser like Blevins Franks Financial Management Ltd. to establish what opportunities are available to include real assets in your portfolio and whether they are suitable for your objectives and circumstances.

By Bill Blevins, Managing Director, Blevins Franks

28th April 2010

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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