Sunday, September 10, 2006

Natural Resources and Portfolio Strategy

What if oil, gas, metals were as steady a bet as the big banks?

Commodities will defy cyclic pattern -- UBS

Ray Turchansky, Freelance

Published: Saturday, August 26, 2006

An interesting research report by UBS released out of Zurich this week hints that the traditional huge price swings in commodities such as oil may not take place during the next 25 years.

If so, that should make them core investments, rather than sector plays that people get into and out of during various parts of the market cycle. That would bode well for Canadian investors, offering some stability to equity markets laden with companies involved in energy and materials.

We've all heard the alarm bells that say we've already reached a peak in the production of oil, and that the world would run out of copper in four months if no more were found.

Instead, UBS Wealth Management Research says we will face a generation of strain on current sources of energy and materials before necessity becomes the mother of invention, when technology and education will bring about significant changes.

In other words, there won't be a rush to produce and therefore consume existing supplies overnight.

It admits that continued strong growth in demand for natural resources will keep supplies "thinly stretched in the near term," but predicts there will be "a peak in oil production within the next quarter century." Similarly, "under-investment in the search for base metal deposits will also limit any immediate expansion in production."

The rationale for thinking we won't run out of energy products and base metals quickly is that despite the rise in prices during the past few years, the prices are actually lower than during previous peaks when you adjust for inflation.

UBS, the world's largest wealth manager, feels that increased near-term demand for energy will be met by production of natural gas and other fuel substitutes, before long-term substitutes are developed that will reduce reliance on crude oil. Similarly, UBS says base metal reserves "are sufficient to meet long-term demand forecasts."

Certainly much of what is predicted is already happening.

Imperial Oil and Husky Energy have already announced delays to major oilsands projects. And Canadian Oil Sands has said that if it wins what has been a three-way battle to take over Canada Southern Petroleum, it would simply stash away the junior company's Arctic islands acreage for the future, because it may never tap into those prospective natural gas reserves.

The combination of a workforce stretched thin causing high labour costs and a sense that crude oil prices aren't about to collapse overnight has reduced much of the urgency to get oil out of the ground.

UBS paints a scenario of high infrastructure and investment costs delaying the development of substitute fuel sources, while geopolitical instability keeps oil supplies low for the next five years. In fact, it's tough to imagine there not being at least one Middle East oil supply at risk due to war at any given moment for the next 20 or 30 years.

Another factor you can throw in is global warming, which now produces an annual threat of a hurricane season that could disrupt supplies, thus renewing oil prices near their current levels on a regular basis.

As a result, UBS predicts oil production will peak in the mid- to late-2020s, and it will be overtaken by natural gas production by 2030, if not earlier.

As for base metals, mining will be hindered by underinvestment plus international trade and legislative restrictions concerning the environment. Therefore, there will be "no issue of depletion in the next 200 years or so for mineral commodities, like ferrous and non-ferrous metals."

Another major reason put forth by UBS for stable energy and base metal prices going forward is a change in where the demand will come from. The report says the gap in per capita income between people from developed and developing countries will shrink, and that "future growth in demand will likely flow from emerging markets."

The idea of energy and base metal companies being a rock upon which a portfolio should be built is a somewhat jarring notion. The S&P/TSX Composite Index is outperforming the Dow Jones Industrial Average and S&P 500 for the fourth time in the last five years. Could that pattern hold for the next five years, or the next 25?

Ray Turchansky is a freelance writer and income tax preparer. He may be contacted at

© The Edmonton Journal 2006

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