33: What’s oil got to do with it?
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
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
Which countries are impacted the most by higher oil prices: The
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
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
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
High negative exposure to high oil prices (importers)
Eastern Europe (except
Neutral exposure to high oil prices (significant energy production)
High positive exposure to high oil prices (exporters)
So to hedge against high oil prices, the best places to invest in property are probably
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