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40: Impact of high oil prices - ways to hedge in property



As described in the May 2005 Newsletter, it seems every time the oil price goes up, the stock markets come down the markets are spooked by oil prices and we cannot see this issue going away. Up until now, the economy has been motoring on fairly well despite higher oil prices because of its momentum, Chinese growth and a strong US growth spurt from lower interest rates and weak Dollar.


In the last few months, things have started to get a lot more serious. It's a crisis in the waiting one could argue. reasons are:


1. There is no more refining capacity - leading to refined product shortages (because of under-investment in the last 15 years)

2. There is no more spare production capacity - all the easy oil has been developed, only remaining suprplus is heavy sulphur crude and there are not enough refineries to process this

3. The US Dollar has risen strongly in the last 5 weeks - up to 20% - crude is sold in dollars - so this makes oil a lot more expensive in Europe. 


The lag between high oil prices and economic hardship is about six months. So by the end of 2005, this could lead to many European countries slipping into recession, particularly as inflation starts kicking in, meaning the European Central Bank will not reduce interest rates below the current 2% to stimulate the economy. My prediction by year end is:

In mainland Western European property price growth are likely to slow markedly - France and Spain in particular from say 12% p.a. to zero. Interest rates should stay the same - with unemployment rising.


In the UK the picture should be a little better since the BoE are likely to drop interest rates from 4.75% to say 4% within a year to stimulate growth - inflation has levelled at 2% whic allows them to do this. This, along with the London Olympic effect and start of SIPPs, plus housing shortage and low unemployment - should act as a stimulous, particularly in London and the SE.  So our view is that after flat prices up to September, prices will start edging up in the Autumn and into 2006. We know not many people hold this view, but then not many people thought prices would double from 2000 onwards - the amount of times a house price crash has been called is beyond mention.


If you wish to hedge against high oil prices, then the best thing is to buy property in countries with a high proportion of GDP generated from hydrocarbon production (also away from developed countries that are have fuel intensive manufacturing and no hydrocarbons like Germany). So the list of top countries in Europe is as follows:


1. Norway  

2. UK

3. Holland

4. Denmark


Norway has "by far" the greatest per capita exposure to oil/gas generating income - at $60/barrel the economy generates a huge surplus.


Countries to avoid would be


1. Italy

2. Spain

3. Germany


Countries which have no oil/gas but a strong dependance on the service and high-tech economy should fair better - examples include Luxemburg, Sweden, Finland and Switzerland.


Any town or city that generates large wealth from oil/gas is a good place to purchase property if you believe the oil/gas prices will stay high. Examples in Europe starting with the best are:



In the USA - top cities would include:



High oil price normally puts pressure on interest rates and acts like a tax and stifles economic growth, so low oil prices are best for higher property prices. But if you feel particularly negatively exposed to high oil/gas prices, buying property in such oil/gas towns could re-balance your portfolio. Other cities to consider would be:



The only other macro-economic comment we would like to make at this point is that - in general - the developed countries without oil/gas also tend to have high environmental costs and regulations - which puts their manufacturing and productivity at a disadvantage to India, China and USA - especially when high oil/gas prices increase input prices further . These countries are therefore heavily exposed to a downturn in manufacturing triggered by high oil/gas/electricity prices. Example are:

German spot electric prices have sky-rocketted recently - in part because of the cost of subsidies on wind power and other renewable and clean fuel sources. France is less affected because it generates all it's electric needs from nuclear power - its is also therefore less exposed on carbon emissions and related environmental costs.


Countries that have the most severe regulations, that do not change in a high energy cost environment are the ones that will suffer the most - top of the list could be Italy. So for a lovely holiday home in a beautiful country - Italy is fabulous - but just don't expect the prices to go up much further - because the munufacturing downturn, competition from India/China/USA, demographics, regulation, environmental constraints, language barrier and high energy costs will all work against such an economy that is already in a deficit. France and Germany, and possibly Portugal could follow suit. UK has better demographics, good oil/gas supply and less environmental costs - so should fair rather better.


Hope this has been of help to you - to give you ideas and insights on property investments with an oil/gas dependancy and positive exposure at high oil/gas prices.



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