Weekly Market Commentary 2-14-2011

"Either we change the way we live or change the way they live"- Don Rumsfeld


With all that is going on in the Middle East I can’t help but reflect on an asset class that has been out of favor the last few years: energy.

Looking at the chart below, out of all US Equity sectors, energy has had the best performance over the last 20 years with a mean annual return of 12%. Looking just at the last three years though, energy has had an annualized return of -3.26%.

periodic table of US equity sector returns

It’s important to consider the alternative though. The energy sector may be on a long downward mean reversion process and could underperform for years to come. It’s too early to come to any defined conclusions but you shouldn’t be surprised when the energy sector, and more specifically oil, continues to experience interesting price activity.

Here are some facts based on numbers from the EIA:

  • United States’ oil consumption is a smaller percentage of world consumption.In 1980 the US was the largest consumer of petroleum and was 27% of world consumption. As of 2009 we were still the number one consumer, but our consumption represented only 22% of the total. I would be stunned if this trend didn’t continue.
    • Looking at the supply side, Saudi Arabia is a smaller part of the world supply. Also, Saudi Arabia’s proven reserves are a smaller percentage of the world’s proven reserves. In 1980 Saudi Arabia represented 16% of the world supply of petroleum; in 2009 it was only 12%. In that same time frame Saudi Arabia’s proven reserves as a percentage of the world’s proven reserves fell from 26% to 20%.


  • Petroleum consumption should continue to increase mainly due to China and India. China and India alone went from 4% of the world’s consumption in 1980 to 14% in 2009.


All of these macro-trends have been in place for many years and have been discounted by some degree to reflect the current market price. However, I believe the long-term changes occurring in the Middle East and its effect on the supply side of petroleum going forward have not been fully priced in.


Using a loose definition of “democracy”, there are at best three “democracies” currently in the Middle-East. According to the Economist Intelligence Unit, Israel is a “Flawed Democracy” while Turkey and Iraq are considered to be “Hybrid Regimes.” My perspective: the best we can hope for are “Hybrid Regimes” in Egypt and Tunisia, bringing it to five “democracies” in the Middle East.


An Oops Moment

What makes this type of democratic tidal wave so unpredictable is that many countries in the region are dominated by religious ideology. These different perspectives become the fault lines for political parties in the Middle East. In Egypt, these ideological fault lines are split between two prominent parties: the “Muslim Brotherhood” and the “Wise Men Council.” I don’t pretend to be an expert on either group or their beliefs, but I don’t think either has fully grasped what has just happened.


The Google Guy


screaming guy

Wael Ghonim is the Head of Marketing at Google for the Middle East & North Africa. To make a long story short, he got upset this summer over an atrocity that occurred in his home country of Egypt. After posting several videos and some timely usage of social networking, he became a leader of this Egyptian Revolution almost by default. I don’t think this guy gives much credence to a group calling themselves the “Council of Wise Men.”


History has seen many revolutions, and we can look to recent examples in Russia, the Balkans, and in Eastern Europe. Despite their differences they all have one thing in common; it is never simple to figure out the winners and losers. Finding out who's elected and what values they will bring to the table will take time, all while the world waits for the oil it deeply depends on.


The last time there was a democratic election in the region was in Palestine, and they elected Hamas. For those unfamiliar, Hamas is an acronym for a phrase that roughly translates into “Islamic Resistance Movement.” They have been classified as a terrorist organization by the United States, Israel, the European Union, Canada and Japan. Democracy doesn’t always make a region more stable. What is even more concerning is that Hamas was founded as an offshoot of the Egyptian Muslim Brotherhood in 1987 during the First Intifada. This makes it even harder to believe in the prospect of lower oil prices.


Unfortunately, if we don’t change the way we consume, we are going to change the way they are going to live. It’s not entirely clear what the consequences in the short run will be on the geopolitical landscape. However, with the instability in the Middle East there is a high probability that both oil prices and the energy sector will continue to be in favor.



TIm Phillips, CEO