What next for oil prices? - 理財

拋磚引玉....

What next for oil prices?

Questions for Fred Fromm, CFA, portfolio manager, FTIF Franklin Natural
Resources Fund (a subfund of Franklin Templeton Investment Funds, a
Luxembourg-registered SICAV)


Summary
‧ Current prices will eventually impact the growth in demand for oil,
but estimating the future balance between supply and demand for oil
is problematic.
‧ The shares of oil producers have not kept pace with the rise in oil,
so downside potential for these stocks may be limited.
‧ New studies into world oil supplies may result in higher oil prices
if the results are worse than expected.
‧ The world may not be running out of oil, but extracting oil has become
more expensive, a consideration that may support high prices.
‧ While the impact of so-called ‘speculators’ on oil prices is difficult
to pinpoint, many are likely basing their decisions on underlying
commodity fundamentals.
‧ We are only beginning to see the impact of soaring oil prices on the real
economy.
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How much further can the rise in oil prices go?
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Unfortunately, it is very difficult to predict oil prices, and a large amount
of guesswork is always involved. Production and consumption are very diffuse
and often opaque, making estimations difficult. Although everyone acknowledges
that OECD demand is softening, most oil bulls believe that non-OECD demand—in
particular in China, India, the Middle East and Latin America—will remain
fairly resilient. The argument that oil prices will remain elevated is
therefore largely dependent on these demand factors—OECD stagnating, but not
falling precipitously, and non-OECD demand remaining resilient.

The other piece of the bull argument has to do with supply availability, which
is impacted by new projects and decline rates in existing fields. Although
projects have faced delays, we have a fairly good picture on planned capacity
additions and, therefore, new supply. However, the behavior of existing
fields is very uncertain given that most of what’s happening occurs deep in

the earth’s crust, and given that there has been a lack of information from
many of the world’s major producers, such as Saudi Aramco. The aggregate
decline rate, which is natural and impacts all wells eventually, can have a
large impact on production capacity.
On matters of both supply and demand, my opinion for some time has been that
non-OECD demand would be stronger than expected and that the decline rate of

existing fields would be higher than expected. This appears to be the case.
However, demand growth appears to be slowing more than expected in OECD
countries. In addition, we are beginning to see signs that the fuel subsidies
in many non-OECD countries that have kept demand artificially high will be
reduced. Such moves should also lower demand growth.

FOR BROKER/DEALER USE ONLY. NOT FOR PUBLIC DISTRIBUTION.
Now that I’ve provided some background, I’ll get to the question directly.
Predictions of higher oil prices are inevitably made with incomplete
information, and investors should treat them as “best guesses.” That said,
as long as demand outstrips available supply, theoretically, there is no
limit as to how high the price of crude oil can go. However, at some point
prices will squeeze out demand, and that should be a limiting factor on price.

That level is difficult to determine, and demand
destruction does not happen overnight, but I believe current price levels will
eventually impact global demand growth.
With that assumption, we can now focus on supply. Many new projects are
coming on line that should increase available supply, but these will be
partially offset by difficult-to-predict declines in existing production.

The difficulty in estimating net new capacity makes estimating the supply and
demand balance (and therefore price) somewhat problematic. It is my belief
that we will move into a more balanced state over the next one or two years
that should result in at least a flattening of oil prices, and possibly a
decline.

So does that mean we should sell energy stocks? Not necessarily. Oil equities
appear to be discounting oil prices of around US$80 per barrel (bbl), far
below today’s price of over US$130/bbl. Put another way, the shares of oil
producers have not kept pace with the rise in oil and should, therefore, have
less downside potential than one would expect. In addition, if investors

become convinced that oil prices will remain above US$100/bbl, we could see
significant appreciation in many oil and natural
gas-related equities. The upside/downside scenario for energy stocks
therefore remains attractive, in my opinion.



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What do you make of the assessment by the International Energy Agency (IEA)
that it may have overestimated the capacity of oil-producing countries to
keep up with growing demand, and that it has become harder to keep supply
and demand in equilibrium?
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In my opinion, there is very little question that the IEA has done a poor job
of estimating both supply and demand. When demand was strengthening in the
early part of this decade, the IEA continually underestimated demand growth,
and over the past couple years has been way off on supply. For instance,
until recently, the IEA was estimating that Russian oil production would

continue to grow at a fairly healthy clip, despite many indications that it
might actually decline, which is what has happened.
Given that Russian production growth had been an important supplement to
world supplies for many years, this was a critical mistake.
It now appears that the IEA is undertaking a more comprehensive study of
world supply, which will, hopefully, provide better insight into actual


production capacity. The problem is that the results of a more comprehensive
study are not likely to be pretty and could result in higher prices if the
conclusion is worse than expected.
Do you believe we have indeed hit “peak oil”?
I’m not a big fan of the notion of peak oil, primarily because there is
still a lot of oil in the world. It just costs more to either get it out of
the ground or to process it, as in the case of oil sands or heavy oil. For
instance, recovery rates (the amount of oil than can be produced as a
percent of oil in place), are only approximately 30%-40% globally.

An increase in recovery rates of just 5% could have a large impact on
available supply. This is why, as a theme, we at FTIF Franklin Natural
Resources Fund* invest in oilfield service companies that provide equipment
and services to aid in increasing recovery rates.
Although Canadian oil sands are an important source of new production,

particularly for the U.S., those developments currently produce only about
1 million barrels per day, or just over 1% of world demand, and that is
expected to grow to only about 3 million barrels over the next three to
five years—still important, but not enough to have a huge impact.
Similarly, the discovery of the Tupi deep-water oilfield and other recently

announced discoveries in Brazil will be important additions to supply, but
not for at least three to five years, which is the typical development time
for deepwater discoveries. And even then, the highest current estimates are
for production of 2 million barrels per day. Most agree that the global
decline rate is approximately 5% per year. This equates to 4.3 million
barrels per day in necessary supply growth just to offset natural declines.

But some think the global decline rate could be as high as 8%-10% or almost
8 million barrels of production per day at the midpoint.To summarize, we are
not running out of oil—yet. However, it is getting much more expensive and
difficult to find and develop. Such considerations are likely to support
prices at a historically high level, for the benefit of producers with
long-lived, low-cost production, such as FTIF Franklin Natural Resources
Fund’s largest holding, Occidental Petroleum.

OXY, as it’s also known, produces most of its oil in California and Texas
using enhanced oil-recovery methods. Production growth is slow, but steady.
But most importantly, the investment required by OXY to maintain production
is low, leaving more cash for growth projects in the Middle East and Latin
America.


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Do you think it’s possible to imagine a sudden fall in demand, not just in
the U.S., but elsewhere?
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Declines in demand are rarely “sudden” given price inelasticity (in other
terms, the lack of reaction in demand to changes in price). However, demand is
already softening in OECD countries and has been softening for a couple years.

Although non-OECD demand has been fairly resilient, it too is likely to soften
, particularly in a global recession. However, I am a strong believer in the
long-term growth of per capita consumption around the world, which will
eventually lead to an overall increase in demand.

In other words, I expect any dislocation in the supply and demand fundamentals
to be short term in nature. If this is the case, any significant decline in
commodity prices and equity valuations should be treated as a buying
opportunity. To clarify, “short term” could be as long as one to three years.


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Do you believe the Fed’s rate-lowering campaign and the U.S. dollar’s slide
have contributed to the spike in prices?
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It’s difficult to separate out the various impacts of a weak dollar. Although
a weak dollar clearly cushions the impact of higher oil prices on non-dollar
economies while leading to a higher price requirement for oil-exporting
countries (in other terms, they need a higher price to compensate for the
weak dollar impact on non-dollar import prices), it’s difficult for me to
imagine that demand in* A subfund of Franklin Templeton Investment Funds, a
Luxembourg-registered SICAV.non-dollar economies increases as a result of a
weak dollar, which would have to happen to increase global demand. However, it appears some investors are using oil as a dollar/inflation hedge, similar to gold. If such a tendency becomes ingrained in an investment discipline, it could lead to a higher price of oil, or help lower prices if the dollar’s decline reverses. It is interesting to note that the most recent rise in oil began as the dollar was strengthening—quite the
opposite of what one might have expected.

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The value of investment funds tracking oil and other raw materials has grown
from US$13 billion to US$260 billion in the past five years. OTC commodity
derivatives have also increased exponentially. So, to what extent are
“index speculators” to blame for the hike in oil prices?
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Again, the impact is very difficult to pinpoint, but I think it is naïve to
say that there has been no impact at all. Pension funds hold an enormous
amount of assets, and a decision to move even a small portion of these funds
into commodities could have a big impact. However, many of these investment
funds’ decisions are long term in nature, and one could argue that these

funds should always have had a large part of their portfolios in commodities.
So, although funds may be having an impact, I don’t think we’re going to
see the situation reversing anytime soon. We have this discussion internally
all the time. Are speculators driving up the price of oil?

How do you differentiate a speculator from a smart investor? These
“speculators” or “investors” are likely considering the underlying
commodity fundamentals when making their bets.

What is your assessment of the impact of soaring oil prices on the real
economy? Some suggest it may take a couple of years for the really big impact
to be felt by world economies.

Although the impact of high oil prices on the real economy is typically slow,
I believe we are seeing the beginning of it. However, the underlying trends of
per capita consumption in emerging economies are so strong that I’m not sure
what’s happening in the OECD countries will matter. In the 1970s and 1980s,
it took two or three years after the Iranian Revolution-induced price spike

for demand in OECD countries to react. But consumption was much less efficient
then, so it will likely take longer this
time around, and consumption weakness is likely to be less severe.
The costs of oil exploration and production (E&P) companies have doubled in
the past three years. What is your assessment of their prospects?
Rising costs for oil and gas producers are always a concern, which is why we
at FTIF Franklin Natural Resources Fund seek out low-cost producers with
long-lived assets and, preferably, the ability to lower costs by applying
new development and production technologies. Many of our E&P stocks, which
are mostly U.S. companies, are growing production by 30%-50% on an annual
basis while lowering per unit costs. These have been some of our largest
holdings and best-performing investments. Southwestern Energy
is a good example.


We have been cautious on oil refiners and integrated oil stocks that also have
refining operations. This is why we reduced exposure to the integrated oil
sector and added to our E&P investments in the latter part of 2007. As demand
softens, it becomes more difficult for refiners to pass-through higher
feedstock costs. However, the share prices of refiners have declined
significantly and appear more attractive as a result, although the outlook
still remains challenging.

Integrated oil stocks, although performing better of late, have still
underperformed other energy-related sectors represented in the fund and,
therefore, appear more attractive on a relative basis. Furthermore, a decline
in the price of oil could be of benefit to refiners and the refining
operations of integrated oil companies. Of course, integrated oil stocks would

also receive a lower price for the oil they produce in that scenario, so there
are some offsetting factors.
In conclusion, the recent explosion in commodity prices has led us at FTIF
Franklin Natural Resources Fund to cast our net wider in our search for
investment opportunities. For the same motive, it is reasonable to expect an
actively managed fund such as FTIF Franklin Natural Resources Fund to look
to take profits in sectors/stocks that have performed well and whose
valuations appear to reflect the company’s prospects.

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