Shares digital

There are some things we simply can’t do without. Got a sweet tooth? Then maybe a regular supply of Mars bars fills a hole. A bit of a techie? An Apple iPhone for you? For the motorheads among us, perhaps the latest V8, twin-combobulated thingamy whizz under the bonnet. But whatever floats your boat, there’s no doubt that commodities are the ‘must have’ accessory for investors just now.

A couple of weeks ago I wrote about the soaring price of gold, yet oil prices have blazed an even steeper trajectory, one not dissimilar to the flightpath of a space shuttle mission. I haven’t seen a chart like this since investors starting slapping dots and coms on the end of every company name to win over City slicker support.

It was only last summer that Goldman Sachs, among the bluest of blue chip investment banks, retracted a note it had circulated to clients – talking up $100 oil – after meeting with widespread bah-humbugging. Today, with oil trading at around $110 a barrel, critics could feasibly reject Goldman’s research on the basis that its forecasts were not bold enough.

In the Christmas edition of Shares, I remember predicting a continued rise in oil prices (I actually said, ‘oil prices would rise to over $110 a barrel before the winter was out’). The stage seemed set for such an eventuality given the supply/demand dynamics, geo-political climate and continued scarcity of new, big discoveries. Yet something is wrong with the way the market is assessing the oil question. Sure, you expect spikes in the price when big events conspire, or even threaten to conspire to strangle supply. A huge pipeline leaks in Alaska, higher goes the oil price. The wind gets a bit stiff in the Gulf of Mexico, higher it goes. Opec dismisses output hikes, higher, higher, higher. If this was Play your cards right, we wouldn’t get a sniff of a Brucie Bonus with these tactics.

But we’re over the worst of the winter months, when heating stocks take their annual buffeting, and given that there are currently few bottlenecks in the supply chain, oil prices are starting to look very much like another investment bubble waiting to burst.

True, oil is clearly being seen as a hedge against a terribly weak dollar, but even factoring this in, oil markets look overegged. Shell’s chief exec, Jeroen van der Veer, admitted this week to finding it hard to quantify, saying that ‘it’s difficult to understand why the oil price is where it is’. He is not alone either. Such is the concern over oil prices – not just their current level, but the rationale behind its explosive surge – that the International Energy Agency (IEA) is now convening a closed-door session with market experts to determine whether supply and demand fundamentals are actually responsible for record crude prices. This is a drastic measure indeed because the IEA, a Paris-based organisation largely concerned with representing the developed world’s big energy users, normally gives a wide berth to discussing prices directly, apart from its fairly routine call for Opec to up output once a year or so, in order to ease pressure on energy-consuming nations. To so brazenly gather experts from the worlds of financial and oil trading, plus executives from the production and refining companies, for talks on the ‘whys’ and ‘hows’ of a string of record-breaking hikes suggests concern runs deep over an apparent disconnect between fundamentals and recent price shifts.

There is, of course, still a string of fundamental factors to support high oil prices. Globally, oil demand is surging, and according to the IEA, world demand for oil has hit about 86 million barrels a day and is expected to grow by nearly two million barrels a day each year. That means that, by the time the Olympics arrive in London, nearly 96 million barrels will be consumed daily to run cars, heat homes, and for manufacturing.

One of the big worries stems from the ‘peak oil’ theory, where we have used more oil than there is left to use in the future. This thesis has existed since the 1950s but it has gained considerably more attention in recent months, given how oil prices have risen; and, depending on who you talk to, global oil production has already peaked, will peak soon, or may not peak for a very long time. According to some estimates, however, production is capable of meeting the world’s increased demands. Today, the global industry produces about 87 million barrels daily, and the IEA says that could rise to 98.5 million barrels by 2012.

Oil optimists also point to new finds, including Chevron’s Jack 2 well in the Gulf of Mexico, thought to have between three and 15 billion barrels of recoverable oil. There are others too: a deep-water well near Brazil and Alberta’s oil sands, which potentially contain almost as much oil as Saudi Arabia. On the other hand, unearthing the oil from many of these new finds is complex. It can be both energy-intensive and extremely challenging from an engineering point of view, and there are never any guarantees of success.

Yet even after taking all of these factors into account, I can’t really see why oil should be as high as it is. The market dynamics have not changed that significantly in six months to justify a near-60% hike in the price, or to have all but doubled in a year or so. So chase oil as an investment if you must, but be prepared for a seismic shift at some point, because sooner or later, the oil market will correct itself.