By Michael Feller PORTFOLIO POINT: The rising cost of oil has much broader implications for investors than the government?s vague outlines for a carbon tax. Australia, on a per capita basis, is one of the world?s biggest polluters. Although we only contribute approximately 2% to global carbon emissions, we punch well above our weight considering our small population. It stands to reason then that a carbon tax, and subsequent emissions trading scheme, is well overdue. Yet despite the media hoopla over the announcement for a carbon tax from July next year, there?s very little detail available to merit a tactical investment response. Indeed, investors exposed to energy stocks may wish to take advantage of the confusion and double up. Investors involved in manufacturing and other polluting industries, on the other hand, face a more challenging scenario, yet one that has nothing to do with this as-yet mystery carbon tax. And that?s the scenario of much pricier commodity inputs, oil and coal in particular. A large number of Australian companies will inevitably face the pressure of costly carbon ? whether this is in 2012 or several years later when the proposed tax is scheduled to switch to a cap and trade system, or later still due to potential ?green tariffs? as our trading partners become more climate conscious. But this is a development that?s very much yet to play out. And while the Commonwealth government?s list of Australia?s biggest carbon-emitters will be essential reading for portfolio screening in the years to come, for the moment estimates of a levy of $20?30 per tonne of CO2 mean that even the sootiest balance sheets are unlikely to be materially affected. With the government already flagging assistance for the most impacted industries, a cynic may question the very point of the levy. More cynical still, the fact that many corporate leaders are behind the tax suggest that it is largely a policy of ?greenwashing? rather than a real attempt to stem the tide. On this basis it?s instructive to look at the modeling the CSIRO has done on the impact of a tax at the petrol pump. Impact of CO2 prices on petrol against various EIA forecasts Source: CSIRO, Fuel for Thought report, 2008; EIA (Energy Information Agency), US Department of Energy See those green lines? They?d pretty much be covered by your Coles 4? discount shopping voucher. But the real value of this chart lies in just how clearly it reveals the elephant in the room ? the rising cost of oil and, in turn, other carbon commodities, such as thermal coal. ? ? ? ? ? It?s here we turn our attentions to North Africa and the Middle East, where civilian uprisings are being met with brutal reprisals, delivering one of the most pronounced supply-side shocks to oil in recent memory and leading many to openly speculate on $US200 a barrel oil based on the likelihood of continued disruptions and further contagion. In 1979, when the Iranian revolution brought down the Pahlavi dynasty and pushed up the price of West Texas Intermediate crude by 250%, further contagion was avoided through the following year?s invasion of Iran by then US ally Saddam Hussein and massive support to the Saudi government, seen at the time by many as the next domino to fall. What?s different in 2011 is that the US is hampered by existing and costly engagements in Iraq and Afghanistan. Further, it can ill-afford to be seen propping up a genuinely unpopular Saudi regime a second time round, should it begin to falter, after former Egyptian ally Mubarak was kissed goodbye by US President Obama last month. In any case, you don?t need Saudi Arabia to fall to have high oil prices, with excess Saudi capacity barely able to cover what Libya, supplying one eighth of Europe?s oil, otherwise provides. As a whole, OPEC (the Organisation of the Petroleum Exporting Countries), has estimated excess capacity of 5.4 million barrels a day, most of it Saudi, and well more than Libya?s total daily output of 1.6 million barrels But idle production takes weeks at best to come online and, as WikiLeaks revealed last month, US diplomats believe that Saudi Arabia may have overstated its crude oil reserves by almost 40%. And as for OPEC?s other sources of idle supply, that?s not looking good either. Venezuela is almost bankrupt; Iran faces tremendous uncertainty of its own; Iraq has more than enough problems; and Nigeria faces another potentially violent election next month while Angola is currently being rocked by protests.
The above graph more than adequately illustrates the increased dependence the world has on Middle Eastern oil since 1979, notwithstanding discoveries in South America, Australia and Africa along the way. And when one considers Published in Eureka Report on March 7 3 Back to Contents that during the Iran crisis the overall loss of OPEC production was merely 4%, the implications for an even more devastating spike in 2011 are clear. Add in today?s level of emerging market demand from places such as China, speculation of peak oil, the increased volatility of prices due to speculation and the de facto moratorium on oil production in the Gulf of Mexico then it?s no wonder that analysts, from hedge fund pioneer Jim Rogers to Nomura?s commodities team, are predicting $US200 oil as well. The big caveat to this, of course, is whether high oil prices will only serve to plunge the world back into recession, as they did in 2008 after a $US147 peak, when $US200 a barrel theories also abounded. Another caveat is whether higher oil prices put a stop to accommodative monetary settings in major consumer China, where commodity price inflation, ex-oil, is already running out of control, partly due to the yuan?s low peg to the US dollar. After all, one thing that?s definite is that higher oil prices add a huge amount of risk to the global recovery story and to Australia?s position as a beneficiary of Asian growth. The political risk premium, as we?re seeing currently in the Middle East, also shouldn?t be underestimated. Not only are the Arab world?s uprisings contributing to potential instability in places as far afield as Pakistan, Vietnam and China, but higher oil prices produced from those very uprisings could lead to further unrest as well. ? ? ? ? ? Yet until oil?s inevitable denouement (higher oil prices, after all, solve higher oil prices) we can expect a commodity blow-off of massive proportions and Australian oil stocks will be key beneficiaries with nary a carbon tax fear in sight. Higher oil contributes to price increases in virtually all other commodities ? hard and soft ? due to its role in transport, plastics, fertiliser and substitution. In precious metals too, as we?ve seen with gold and silver, higher oil is contributing to safe-haven investing. It?s also helping coal, insofar as importers are stockpiling. And even if predictions of $US200 oil come to naught, the recovery in macroeconomic sentiment can in any case be expected to drive stocks higher and keep the emerging markets commodity super-cycle going. Obviously there will be several oil, gas, engineering and thermal coal companies whose shares, in the run-up to higher energy prices, will become toppy and thus risk a big correction. But the list above shows that value is still to be had in the energy sector. And, as we know, value in the long-term is resilient to price volatility in the short-term. My conclusion, to go long energy, may seem counter-intuitive during a debate on the proposed carbon tax, but such is the nature of the market. Competing thematics and signals are always a challenge for investors, but in terms of the current oil trade, Middle East instability, for now, clearly trumps carbon tax concerns for me; sorry, Ross Garnaut. But as always be aware of unrestrained enthusiasm, volatility and always be cognisant of value, evidenced in particular by forward price/earnings multiples. But make no mistake: the energy price boom is not over yet.
AUT Price at posting:
$2.80 Sentiment: LT Buy Disclosure: Held