With OPEC’s Vienna Accord to cut oil production, Russian production moves, and projected post-election oil and natural gas prospects in the U.S., the market’s attention has been focused on the supply side of the market.
But it’s the demand side that’s now once again moving up – across a rather broad spectrum of energy sources, too.
And what’s really surprising is where this demand is coming from. Asia, as you may have guessed, is still in first place when it comes to energy demand growth.
But in second place is a region most investors don’t even think about.
Here’s how you can best play it…
OPEC’s Deal Will Cut Surplus Volume
The supply discussion when it comes to crude and natural gas centers on restraining the volume going into the market. This is all about whether the agreement struck between OPEC and non-OPEC producers (mainly Russia) over the weekend will hold.
Following two years of declining oil prices, primarily the result of the Saudi-led OPEC decision to defend market share rather than the price leading to a rapid rise in aggregate production, all attention has been on cutting/capping supply to improve the price.
The goal here is the establishment of a market balance between forward-looking supply and demand. This balance does not require that the market surplus, which has prevented a more rapid increase in price, be entirely drained. In fact, while the market surplus has been declining, its continued presence actually provides a buffer against volatility.
Just look at Mexico to see what happens when this buffer is too small…
Look at Oil’s Price Floor, not Ceiling
The country has only a few days of excess refined oil products supply. That both guarantees volatility, and has led to the first move to build a refinery in the U.S. in decades.
In all of this talk about balance there is only one element you need to watch when it comes to estimating prices. This is not the current price itself or even the ceiling of the price spread. It’s the floor.
As the pricing floor rises, everything else follows. It is the floor that dictates what traders see as the downward risk in setting contracts. An improvement there translates into a broader rise in the price itself.
Yet oil and natural gas prices must also consider excess extractable reserves. Operating companies can (in theory) at any time lift considerable additional volume, throwing the supply side out of whack.
That is another reason the balance is important. Attention to the bottom line dictates that companies maximize the return on production, thereby tempering excess extraction. But until the Vienna Accord, there was no reason for a country to reduce its oil production.
Instead of increasing prices, doing so would just give up market share to competitors, in a brutal zero-sum environment.
owHowHowever, all of this is beside the point if demand is declining. That will always depress prices, even if the supply side is restrained. So naturally, now that we’re on the “other side” of Vienna, it’s the demand side of the balance that’s drawing attention.
In fact, all throughout the fallout of the November 2014 OPEC decision to protect market share instead of oil prices, oil demand has continued to rise. What’s important to note here is twofold.
First, that demand has strengthened beyond oil across the energy spectrum, especially in electricity needs. The three main sources of energy demand projections – OPEC, the Paris-based International Energy Agency (IEA), and the U.S. Energy Information Administration (EIA) – are all noting an acceleration in energy requirements globally.
Second, this demand increase is quickly becoming a regionally-driven force. While there were improvements in demand virtually worldwide, Asia is the main source of growth, as you’ve seen here in Oil & Energy Investor before. All indications point to Asia driving global energy needs through at least 2035.
But what is less known is the continent with the second-largest surge in energy demand – Africa. In fact, West Africa leads the world when it comes to increasing demand for electricity.
Africa’s rapidly growing energy demand is both a sign of hope for the continent’s population, and an investment opportunity for use. But it also illustrates a recurring problem, witnessed there and elsewhere…
Take Nigeria, the largest nation in Africa and an OPEC producer of highly-prized light sweet crude. This is the most desired oil for refining since it is the least expensive to process.
The country also has a major need for power generation. Unfortunately, its power generating sector is a disaster, providing only about 25% of the electricity needed on any given day. That means most of the country relies on local and private diesel generators.
Yet this major producer of oil has a woefully inadequate refining network, meaning that most of the diesel essential for domestic life must be imported. Exporting the raw commodity (crude oil) and importing an essential finished product (diesel) creates a vicious demand cycle that not only depresses local development but allows for rampant corruption.
On this latter point, several years ago, I decided to see how far I could go in setting up a legal diesel importing structure into Nigeria, providing a domestic transparent network of distribution to increase local employment and business development.
I still can’t tell where my diesel ended up… or my investment, for that matter.
Nigeria may be an extreme example, but it is illustrative of a larger, global problem. And that’s why I generally recommend investing in companies that profit from international energy demand, but are based closer to home…
Make no mistake about it. The energy demand acceleration – in Asia, Africa, and elsewhere – is going to reveal some major investment opportunities. While the market in which the demand spike occurs may be overseas, the companies providing the expertise, equipment, technology, and infrastructure design will be well within our reach…
Regardless of politics and elections, here or abroad.
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