Where now for the resources sector?

Martin Currie's Duncan Goodwin examines how the crisis in the Middle East is affecting oil prices and the resources sector.

The pace of recent events in the Arab world has been astonishing. Since December’s protests in Tunisia brought down the Ben Ali regime, civil unrest has swept through North Africa and the Middle East with the speed and intensity of a house fire. And as with a fire, it is hard to predict where the turmoil will stop and what will remain once it does.

As managers of Martin Currie’s Global Resources strategies, we claim no special insight into this aspect of the ‘Arab Spring’. We are bottom-up stockpickers, not political analysts; as far as the future political landscape of the region is concerned, we, like everyone else, can only watch and hope for a peaceful resolution.

But aside from the social and political changes that are already in train, the turmoil will obviously have economic implications both for the region and the wider world. Here we do feel qualified to comment – from a stockmarket perspective, the disruption in the Middle East will be most keenly felt in the resources universe in which we invest. So, although we are making no short-term trades around the disruption, we are keeping a close eye on the macroeconomic consequences.

Rising oil price

The most obvious development to watch is the oil price. As investors worry about disruption to supply, Brent crude oil futures have reached their highest level since August 2008. In the short term, the rising oil price supports the share prices of companies that produce the commodity.

And as higher prices tempt oil companies to increase their capital expenditure, the outlook is improving for oil services – a sector to which we have been building exposure for some time. Even before the upheaval, a recent survey of oil-company capex suggested that 2011 budgets would be up 10%–15% year on year. That figure is now likely to be significantly higher.

On the other hand, the share prices of firms with substantial operations in the affected areas are liable to come under pressure in the short term. Having exposure, as we do, to a broad geographical spread of oil and gas producers allows investors to benefit from the rising oil price without necessarily being exposed to Middle Eastern risk. Plays on Canadian oil-sands are a good example, as is exposure to more conventional production in places like Brazil and Venezuela.

Stocks in previously unloved European natural-gas companies such as Gazprom should benefit if the unrest in Libya is not resolved soon, and rise further if protests in Algeria spill out of control; both countries are big suppliers of piped natural gas to the European market.

In the medium term, if high prices persist, OPEC may move to increase the supply of oil. As Saudi Arabia is the only country with enough spare capacity to make a difference, its heavier, higher-sulphur crude would flood into the market, widening the price differential between light and heavy crude.

This could improve the outlook for complex refining, which as an industry has been boosting its capacity to transform heavy crude into more valuable light products. The situation is particularly interesting because the short-term implications of the crisis are negative for refiners, as they struggle to pass on sharply higher crude prices to consumers; any attendant share-price weakness could present a buying opportunity here.

More generally, in the longer term, the instability in the Middle East will surely reinforce the idea that the world should lessen its reliance on one politically volatile region for its energy needs. This could be good news for North American natural gas – a reliable, domestic and relatively cheap commodity – and for alternative-energy sources worldwide.

Diversifying portfolios

But as our portfolios demonstrate, investing in global resources is not ‘all about the oil price’. Contrary to popular perception, the ‘resources universe’ is hugely diverse and extends well beyond primary producers of hydrocarbons and mined commodities.

While some more traditional resources funds do concentrate almost entirely on these areas, we prefer to maintain considerable exposure to a number of uncorrelated sectors. These not only serve to diversify our portfolios in the face of unpredictable events, but also offer great potential for share-price gains in their own right. One such uncorrelated area we currently favour is paper and packaging, a sector which offers a rare combination of strong growth, consistent cash generation and attractive valuations.

This illustrates the attraction of the resources universe. It is not a tight-knit group of stocks dependent on a single commodity cycle, but a wide range of opportunities in distinct, unsynchronised cycles. And with resources-related stocks accounting for around a third of global market capitalisation, the range of opportunity is staggering.

As with natural disasters like the recent floods in Australia or man-made events like last year’s Macondo oil spill in the Gulf of Mexico, it is in this broader context that the upheaval in the Arab world has to be seen. So while we will not be rushed into any hasty moves, we will certainly be monitoring the unfolding drama for the very different short-, medium and long-term implications it may have for resources equities around the world.

Duncan Goodwin is sector manager, energy at Martin Currie.