Oil looks slippery

How long before oil joins gold as the new fashionable sector in which to invest? The equity market might have responded charitably to BP's figures but the oil price continues to languish well below dollars 20 a barrel, and half the level in real terms that it stood during the early 1980s. Meanwhile, investors are advised by some leading stockbrokers such as Smith New Court to remain underweight in the sector. At some stage there will be another oil boom, but when?

Anyone trying to predict oil prices will, if past performance is any guide, get it wrong. But while it is quite impossible to get the profile of the oil price over the next 10 years right, it is possible to point to the underlying pressures that will tend to push it up. Two are worth special attention, one general, the other particular.

The general one is that within 10 years the perception will start to take hold that oil supplies are about to become tight. Proven oil reserves have stood at around 30 years' consumption for most of the 1980s, with new reserves (or new ways of extracting a higher proportion of known reserves) matching production. One can look at this from a company point of view too: last year BP added the equivalent of 124 per cent of its production to its reserves, against an average of 86 per cent for the eight leading oil groups. Over the past five years the average reserve replacement rate for the eight groups was 101 per cent. In other words, as a group, they found as much oil as they pumped.

One has to take these figures with a pinch of salt, because estimates of reserves are a bit like accountants' profits figures: in the short term the oil companies can produce pretty much whatever figure they want, depending on the assumptions they make. But while this rough balance continues, there is no obvious reason for the oil price to rise.

It will not, however, continue indefinitely. Two or three years of reserves rising by only, say, 50 per cent of output and some unpredictable political shock would together start to shove the price back towards the real levels of the early 1980s.

The particular issue is China's future demand for oil. East Asia in general is short of oil reserves. Its biggest economy, Japan, has no oil. Its most populous, China, does have some reserves, but less than western Europe. Its current production is running at 2.8 million barrels a day, which makes it the sixth largest producer in the world and a modest net exporter. (Britain last year pumped just under 2 million barrels a day.) But China's rapid economic growth will, according to Fereidun Fesharaki, president of the International Association for Energy Economics, make it a net importer by 1994 or 1995. Speaking at a conference earlier this week in Singapore, he estimated that by the year 2000 China would need to import between 600,000 and 1 million barrels a day.

This assessment that China would soon become a net importer was echoed at that conference by Masao Itoh, of Nippon Oil Company, who thought that China would be a net importer by March 1994, and by Robert Weaver, of Chase Manhattan, who pointed to the regional impact of China's appetite for oil. Already East Asia has passed Europe as the second-biggest market for oil, and it may well pass the US, the largest market, by the end of the century.

If this is right, and it is quite difficult to see the circumstances that might change the picture, there are two interesting consequences. One is that the oil price will increasingly be determined by decisions taken in the Far East. The price will still remain market-driven, of course. Supply decisions will continue to be taken by the producers, but demand will be determined by the growth and conservation efforts of Asia.

The other is that the countries that can find the oil will no longer be the countries that use it. Finding and extracting oil is a Western skill. Japan has never found any; the Russians can find it but have dreadful difficulties getting it out. China will need Western help to develop its production much further.

For two generations the underlying tension in the oil trade has been between the western oil companies, which basically represent the consumers of North America and Europe, and the principal producers of the Middle East. That will change. The main producers will still be in the Middle East, because that is where 70 per cent of the world's oil is located. The skills will remain in North America and Europe. But the demand will come from Asia. Suddenly the game will become a three- way tussle, not a regular tug-of-war.

When that happens the oil price is liable to become as unpredictable as it was in the second half of the 1970s, when changes in the balance of strength in the tug-of-war caused the two oil shocks. More than this: oil will again become an important political weapon. Expect China to seek to build relationships with Middle Eastern countries in much the same way that Japan did with Iran when it felt its supplies threatened.

And the timing of the next oil boom? Not, in all probability, until China does become a significant importer of oil, which means the second half of this decade. But if the switch from exporter to importer really does come in March 1994 . . . well, that is less than a year away. Suddenly that vague phrase 'the second half of the decade' becomes rather close. Expect a tightening in the supply of oil to accompany the next global boom, and maybe help to curb it. Expect investors to move long before that.

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