Keeping an eye on energy markets

26 February 2015

Keeping an Eye on Energy Markets

The last quarter of 2014 saw very volatile trading in global commodity markets, but none were more volatile than oil prices. So, what’s happening in the global oil market?

Well, it has certainly been an extremely interesting period for energy markets, with the price of oil having fallen from over US$110 per barrel, just a few months ago, to around US$55 at the New Year. The oil market has, for many decades, been somewhat of an artificial market. One group of producers, the Organisation of Petroleum Exporting Countries (OPEC), has strongly influenced oil prices by changing their production as the level of oil demanded changed in order to keep prices stable and somewhat elevated.

What has changed?

In recent years, technological advances have enabled the available supply of oil to increase. The most significant examples of this have been the development of non-traditional supplies such as oil sourced from bitumen sand – known as tar sands – primarily in Canada, shale oil, through the increased usage of ‘fracking’, and the injection of liquids at high pressure to stimulate production, into existing oil wells.

These changes have added approximately five million barrels per day to the potential production capacity globally. These newer production techniques are typically more expensive than traditional sources and so, have only really become mainstream in recent years, when oil prices have been elevated. With the recent fall in oil prices, there is significant risk that these non-traditional sources will become unprofitable and that production capacity will be reduced.

Oil price over the last 10 years

Why does oil matter?

Oil is only one form of energy, but it is the form that is used to produce most of the energy sources that drive the world’s transportation. Oil-based products, such as petroleum or diesel, are used to power ships, trains, aircraft and road-based transport to move the goods and services that we consume, from producers to households. Energy is also a critical input to the cost of production. So it has a very strong flow-on effect to economic growth. Lower energy costs allow manufacturers to produce and ship their goods to consumers at lower prices. Consumers, not spending as much on filling up their cars, will tend to spend more on other goods and services, stimulating economic growth. Overall it is estimated that the recent fall in petrol prices will add 0.3% to global economic growth*.

Top 10 Oil Global Producers

How is State Super Financial Services managing this issue?

As an investor, we have typically had a moderate exposure to commodity-producing companies, including oil companies. This is because the value of these businesses can be more volatile, as the price of the commodity they produce can be highly cyclical. We seek to generate more stable returns for our members as they approach, or are in, retirement. This helps to reduce the potential impact a fall in the market can have on their retirement income.

Another important issue is that the previously higher energy prices had supported the development of alternative fuel sources such as solar or wind. We see ongoing progress in this area as important in managing the full range of risks that traditional energy sources can create for investors.

To ensure we understand these risks and are responding accordingly, we are currently undertaking research on the potential impacts of climate change in conjunction with Mercer, our investment consultant. The results of this research will be included in client updates over the coming year.

*Source: Citigroup