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Here are key thoughts:
- Tight inventories and rising demand created an upward pressure on oil prices, even before the war in Ukraine. Sanctions against Russia have created additional strain on the oil supply, while demand for oil has already surpassed pre-pandemic levels, with international travel not yet fully restored.
- Different grades of oil are hard to replace. Crude oil is refined into consumable products (such as gasoline, diesel, kerosene, etc.) with each refinery capable of processing specific grades of crude oil. For instance, China may have limited capacity to process the medium sour type of crude that is produced in Russia, while India can process various grades of oil and hence, has more flexibility to change suppliers.
- Higher oil prices should incentivise production. Oil companies have reduced investment in expanding production and exploration based on the history of lower oil prices and environmental concerns. Currently, there is limited capacity to increase oil production with the existing facilities. Additional capital investment will be needed, and companies are unlikely to invest unless they think oil prices will stay elevated.
- Natural depletion of oil production capacity at the wells suggests the need for increased production elsewhere. Oil production at any given well normally drops 3%-5% per year. The increase in production in Guyana and West Africa is not sufficient to replenish the depletion of existing wells, requiring more oil production elsewhere.
- Investments in renewables are crucial to reduce the dependency on oil and gas, especially amidst the war in Ukraine. The cost of raw materials has increased, but this has not stalled renewable energy. As countries look to reduce dependence on Russian oil, the opportunity in renewable energy remains high, in our view.
As we continue to process the many immediate and potential impacts of the war in Ukraine, I want to personally acknowledge the loss, grief, and uncertainty being faced by so many in the current situation.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.
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