WHEB Commentary

Ted Franks

Our view of the falling oil price


Amidst the significant moves in equities and bonds over the last month or so, another indicator has been drawing a lot of attention.  Crude oil is on a four-month down trend.  The Brent benchmark variety has fallen from a high of $115[1] per barrel in June to around $86 as I write.  To put this in context, the last time it was as cheap as this was November 2010.  So this looks like a relatively historic move.

Brent crude, $/ barrel

Brent crude, $/ barrel

Making and using energy has a huge impact on sustainability and likewise many of the investments our Fund makes are linked to the energy market.  As at the end of September, our Resource Efficiency theme is the largest in the Fund with 24.8% exposure, and pretty much all of those companies provide ways to keep energy bills down.  Although relatively small at 3.8%, our Cleaner Energy theme is directly exposed to energy prices.  There are also lots of stocks with meaningful exposure in the other themes, especially Sustainable Transport.

So if we are investing in companies that reduce fuel bills, and fuel bills are coming down anyway, should we be looking to switch into some of our other themes that aren’t so exposed, such as Health?  We don’t think so, for three reasons.

The first is that the oil market is not exactly the energy market.  The linkages are there, but they are changing all the time, and have generally weakened since 2008.  All kinds of intervening factors, such as taxes and new technologies, mean that falling oil prices on global markets don’t always translate to fuel bills coming down.

The second reason is that, as historic as this oil price shift might look, it’s still not enough to undermine the technologies we invest in.  Here’s an example close to home: one of our holdings, BorgWarner, makes a turbocharger for Ford’s Ecoboost engine which improves the fuel economy of the ‘SMax’ by 20%[2].  Conservatively we estimate that it adds around £500 to the purchase price.  Crunching the numbers suggests that for an average UK driver, crude prices could drop a further 50% before that doesn’t make sense.

BorgWarner's K03 Turbocharger

BorgWarner’s K03 Turbocharger

The third reason is that crude prices can of course go up as well as down.  The long term picture is that cheap oil is clearly getting much, much harder to come by.  The huge expense of extracting new sources of oil, most notably US shale, has meant that upstream oil capital expenditure has nearly trebled in real terms since 2000, whilst over the same period headline production of crude oil has only increased by 11%[3].

This dynamic has underpinned oil’s high price since 2010.  It will provide an effective floor on energy prices for a long time, probably until cheaper alternative sources such as solar power can take over.  In the meantime it will continue to make sense to invest in sustainability.

 

[1] Source: Bloomberg

[2] Source: Borg Warner ‘TurboNews’ Newsletter 1/2010

[3] Source: Kepler-Cheuvreux Research Report ‘Toil for oil spells danger for majors’ 10/2014

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