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The oil price surge and your portfolio

How does the oil price spike change valuations for BHP and Woodside?

In theory, changes in the oil price ought to change the value of businesses that produce oil. It's a big reason why oil producers are so volatile; they track a volatile commodity. 

Some investors may mock a market which moves prices around vigorously and often (yep, I've done it) but that is the efficient market working. Changes in commodity prices ought to be reflected in changes in equity prices. 

One of the most reliable edges we have as small investors is a long-term horizon. By not reacting to every short-term change in value, we can concentrate on long-term value. Patience, insight and a little luck go a long way in helping to outperform.

Short-term changes in commodity prices - even if they are large in magnitude- don't necessarily change long term value.

Unless, that is, expectations for long term commodity prices change. So here is the question: does the attack on Saudi oil installations change our expectations of oil prices? 

Some say they might. There are suggestions that supply could take months, or even years, to repair. The chief executive of Oil Search, Peter Botten, has argued that the attack ought to raise the risk premium attached to oil and hence permanently raise prices. That is possible.

When iron ore supply was disrupted earlier this year, we changed our valuation on Fortescue Metals. Does a similar scenario in oil change valuations for portfolio holdings BHP and Woodside? No.

Iron ore is a tight oligopoly with Vale, BHP, Rio and Fortescue accounting for almost 90% of the global seaborn iron ore trade. 

When the largest of that group, Vale, faces difficulty, the supply gap is hard to fill quickly. Alternate sources of supply are limited by resources, infrastructure and incentive. That's not be the case for oil.

Saudi Arabia supplies about 10% of the global oil market and about half that output might be impacted by the attack. Although there is a real disruption to supply, other sources should easily be able to cover the shortfall by pumping more capacity, releasing supply from storage and from easing demand that accompanies higher prices. 

The oil price surge, in our view, won't last long. 

Investors in this sector are warned to expect volatility - that works on the upside as well as the down. BHP remains a HOLD and we maintain our Buy and Sell prices on the stock. Despite a recent jump, Woodside remains below our trigger price. BUY
 

Note: The Intelligent Investor Model Growth and Income portfolios own shares in BHP and Woodside.

The Intelligent Investor Equity Income fund owns shares in BHP.

 

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