Global Macro Investing, Part IX

In my previous article, I noted that we will explore certain commodities in greater detail. So, let’s get right to it and take a look at crude oil.

Crude Oil

The top 3 oil producing countries are Russia, Saudi Arabia and the United States. Together, they account for over 30 million barrels of oil per day (bopd). The other key players are China, Canada, Iran, Iraq, UAE, Kuwait and Mexico.

Oil production chart

Crude oil is not a uniform commodity; there are different crude blends defined by their API Gravity and sulphur content. API Gravity is a measure of how light or heavy the oil is compared to water. Oil which is light with low sulphur content is more valuable since it requires lesser processing by the refinery.

Hubbert Peak Oil Theory

American geophysicist King Hubbert presented a paper in 1956 to the American Petroleum Institute stating that conventional oil production would peak by around 1970 in the US and by the mid-2000s worldwide. Some took his theory to mean that the world will soon run out of oil, while others pointed out that the world has enough reserves to last mankind for eternity.

The key missing point is the use of the word “conventional”. While conventional oil production has indeed peaked, the world is now experiencing a massive boom in unconventional oil production, brought about by the shale revolution.

Oil Prices

Quoted prices of crude oil generally refer to the spot price of Brent crude oil. There are two other benchmarks: West Texas Intermediate (WTI) and Western Canadian Select (WCS) crude oil.

The below chart shows the price of Brent Crude since the 1970s

Brent crude 1971-present

(Note: updated chart on 22-March-2016)

As is evident from the chart, oil prices have experienced two spectacular declines in recent times, the first due to the Global Financial Crisis of 2008 and the second, most recently in 2014. Industry insiders expect oil prices to remain low for the rest of 2015. While oil prices have bounced off their low, slowing global demand and higher inventories (as well as production) imply that barring any black swans, oil prices will continue to trade in the $60 range this year. This gives patient investors an opportunity to buy solid companies with good fundamentals at reasonable prices.

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