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The final presentation at the MIC 2011 was given by Robin Batchelor, Joint CIO of BlackRock’s Natural Resources Equities Team, on a topic at the forefront of many investors’ minds: energy markets.
He started with the foundations of energy investing, namely understanding oil supply and demand. Non-OECD countries surpassing OECD countries in terms of oil demand has introduced a structural change to the market, he said. The surge in oil consumption from emerging markets’ rapidly growing and urbanising populations is a trend that will introduce volatility to the market, Batchelor added, but it is a trend that will be difficult to reverse. Developed markets, on the other hand, will be using increasingly smaller amounts of energy as they focus on efficiency. This makes the oil demand story all about China, the Middle East and India, he said. It is a long term growth story, Batchelor added, but one which the short-term business cycle every now and then interrupts.
There is a key difference between the role of China in the oil market versus the mining markets, he pointed out. For both sectors, China is the biggest growth area, but while China is the largest consumer on the mining market, the US is still the biggest consumer of oil. Recent developments in Japan and the shut down of 11 gigawatts of nuclear energy capacity will also likely have a “material impact” on demand in the short term.
Against this outlook for oil demand drivers, Batchelor built an image of trailing supply markets. He added that tensions in MENA, and Libya in particular, are a key risk. To continue exporting at the same pace, Libya would require $2.3 billion of capital investment per year and major oil companies are still waiting to see how the situation unfolds. In the interim, investment will be ‘parked’, Batchelor said. An oil distribution such as this one takes many years to get back on track, he added.
In addition to being a strain on oil supply itself, Libya is also an example of what might happen elsewhere in the region, Batchelor said, and pointed to Bahrain and Yemen among others as volatility factors. He explained, however, that most Middle East nations are in a somewhat different place from those of North Africa, as they have larger balance sheets and have already been investing in energy infrastructure.
Will there be demand destruction in the oil market? Well, it is hard to come up with substitutes and consumers are more likely to cut other goods before reducing their oil demand, he responded. We are approaching the level where oil burden is reaching demand destruction levels, he said, but we are not there yet. In the UK, Batchelor believes that such a level will be reached if the oil price stays at $120-$130 per barrel while GDP growth keeps at its current pace. That said, the market is already pricing in a significant decrease in oil demand compared to last year, he said. Whether at this or other levels, there is a fundamental underpinning of high oil prices, said Batchelor. He estimates the price of oil should be somewhere between $80 and $100 dollars.
Natural gas prices, however, have no real reason to rise alongside oil, he said. It is a different market, with different end users and significant difficulties in transportation, which makes it subject to a different supply-and-demand dynamic. One development on the gas market that Batchelor focused on was shale gas exploration, both in the US and in Europe in countries such as Poland. While still in its early stages, shale gas has significant potential, he said.
All in, Batchelor believes energy markets are tightening and becoming incrementally more volatile, but given the sheer size of the sector, believes it needs to have a full weighting in investment portfolios.
In terms of finding opportunities, Batchelor outlined a couple of trends. Firstly, his team is finding appeal in smaller capitalisation companies. Secondly, he expects oil services companies to get additional pricing power on their balance sheets. And thirdly, some integrated oil companies are positioned to be hurt more from the increasing costs in oil extraction and production.
