PropertyInvesting.net: Property Investment Special Reports

33: What’s oil got to do with it?

03-19-2005

 

PropertyInvesting.net

 

This article sheds some light on the affect that oil prices have on property investing – you might think there is no linkage, but the bad news is, there is!  There are some very interesting economic dynamics going on which PropertyInvesting.net will enlighten you with:

 

Oil up, stocks down?:   Has anyone noticed recently the correlation between oil prices going up and stock prices coming down? The reason for this is because the markets fear that company profit margins will be put under pressure as energy prices rise, and also worry about the affects higher energy prices will have on inflation and hence interest rates. Higher oil and gas prices act like a tax, and generally make return on investment lower.

 

Oil up, gas up?  Yes – there is a fairly strong link between oil and gas prices – in some areas that rely heavily on Liquid Natural Gas (LNG) imports like Japan and Korea, the LNG gas price is directly linked to a mixed cocktail of crude oils. There is normally some lag, but when oil prices rise, natural gas prices and petrol price normally follow within a month or so after. This then feeds into electricity prices to the end consumer.

 

Oil up, inflation up? Yes – higher oil prices lead to inflation, though this is not as strong a relationship as it was in the 1970s and 1980s, because most wealthy countries with strong service economies now need less energy per capita of production. When our economies in the UK, Europe and USA were more reliant on heavy industry and manufacturing in the 1950s-1980s, higher oil prices had a more severe and damaging impact on the economy. The oil price rises of 1972 and 1982 led to recessions in western countries.

 

Which countries are impacted the most by higher oil prices: The UK is almost self-sufficient in oil and gas so the impact is marginal – furthermore, the dollar’s value has dropped significantly against most other currencies recently, which has helped lessen the impact for such countries.  Germany and France import most of their oil and gas, so their economies have been impacted far more than the UK from higher oil prices. That said, the Euro is very strong against the dollar (the currency oil is sold in), so the impact of oil prices rocketing from $25 to $55 is only half of what it would have been without the exchange rate change in the last two years. USA imports most of it crude oil, and has also not had any positive impact from the exchange rate - furthermore, the country has a huge budget and current account deficit. So the impact for the USA, which is heavily reliant on foreign crude, it very high. Other countries that are very exposed are Japan, Korea and India. China produces about half of it’s oil requirements, but their demand is increasing at about 15% per year. Because the country has very low labour costs, has a current account surplus and high growth, the high oil prices will only dampen their already strong growth. The Chinese currency being pegged to the $ would not help them, but the higher oil prices should not impact China too much for now.

 

So what’s the link with property? It seems when oil prices rise, customer and investment confidence is hit because of the uncertainty on inflation, GDP growth rates, interest rates and stock prices. If inflation goes up because of oil prices, interest rates will follow and this will affect GDP growth rates, stock prices and property prices. Currently oil prices are $55 per barrel, but for every $10 per barrel, many experts believe GDP growth is reduced by about 0.3%. So if the oil price rise to $100 per barrel, this would reduce GDP by some 1.35% (from say 2.5% to 1.15%).

 

Why are oil prices going up – is oil running out? Oil is NOT running out. That said, most of the easy oil has been produced and the unit costs for producing oil is increasing. The big problem at the moment is that spare production capacity has dropped from some 5 million barrels/day about 5 years ago to between zero and 1.25 million barrels/day now. By the end of 2005, it’s likely that global demand will increase by about 2 million barrels whilst about 1 million barrels of extra production will be bought on stream. Essentially, production capacity is very tight and it’s only Saudi Arabia (and possibly UAE) that have any spare capacity to speak of – even this is disputed by some.

 

Add to this the lack of spare refining capacity because of lack of investment in the downstream (due to low refining margins for the last 10 years) and the complex array of refined products that need to be distilled and distributed because of new environmental legislation – means we also have a significant tightness in refining capacity. So you put the two together and it frankly does not look very encouraging.

 

The lack of investment in upstream production is likely caused by the governments of OPEC producers who have the bulk of the proven oil reserves – deciding to spend their money on social and public projects rather than increasing capacity. This is partly caused by OPEC having quotas - these do not stimulate investment in spare capacity. OPEC are now most likely to be producing flat out – most producing countries have probably been doing this for some time. But revenues will most likely be funneled into social projects rather than expanding production facilities. It’s difficult to see the incentive for OPEC for increasing capacity, save creating a sustainable business that does not switch away from oil to other forms of energy.

 

Most western countries have oil reserves that are far more expensive to produce and frankly, western oil is running out, fast. There have not been any major discoveries of new basins made in western countries for many years – the days of the large North Sea (1965-1980) and Gulf of Mexico basin (1950-1995) discoveries are over.

 

So what should you do with your property investment portfolio if the oil prices go up further: The message is, the higher the oil prices go, the more likely your property portfolio will reduce in price, unless you have property in a country that is a net exporter of oil. If you have properties with high cashflow you should not need to worry, but if your cashflow is neutral or negative, high oil prices could lead to property prices dropping (through inflation, higher interest rates and lower GDP growth), and even negative equity if you are highly geared.

 

PropertyInvesting.net has done an analysis of the countries we believe are most exposed to high oil prices, and we have listed these below. If you want to balance your portfolio to take into account high oil prices, best options are property investment in the Middle East!

 

High negative exposure to high oil prices  (importers)

USA

Germany

France

Italy

Japan

Korea

India

Pakistan

South Africa

Spain

Switzerland

Austria

Czech Republic

Sweden

Finland

Belgium

Luxemburg

Thailand

Ireland

New Zealand

Morocco

Tunisia

Balkan countries

Eastern Europe (except Ukraine)

 

Neutral exposure to high oil prices  (significant energy production)

China

Canada

Australia

UK

Bahrain

Holland

Denmark

Ukraine

 

High positive exposure to high oil prices  (exporters)

Saudi Arabia

UAE - Dubai

Oman

Norway

Russia

Iran

Iraq

Brunei

Malaysia

Venezuela

Libya

Algerian

Qatar

Nigeria

 

 

So to hedge against high oil prices, the best places to invest in property are probably Dubai, Moscow and Norway – for the UK you need to look at Aberdeen, although production is declining the revenue and activity levels will be going up. In the USA, Houston, New Orleans, Dallas, Oklahoma, Bakersfield in California, and some parts of Alaska are major oil towns, which will locally benefit from high oil prices. Wyoming will also benefit from a coal mining boom – the area has the largest reserves of high quality coal in the world!    

 

Any comments or questions, please contact us on enquiries@propertyinvesting.net

 

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