Global Asset Allocation: Crude Calculations

Fully updated through end-2017, this case examines the oil market. The protagonist's task was to decide whether her pension fund should allocate some funds to oil, and if so, how much. The decision requires an assessment of oil's features as a strategic component in any portfolio as well as whether the time is right for an opportunistic tactical allocation. Factors that must be considered include how supply and demand for oil will be affected by global economic policy, geopolitical concerns, the availability of alternatives such as natural gas, and rising demand from emerging markets, among other factors. Excerpt UVA-F-1647 Rev. Apr. 2, 2018 Global Asset Allocation: Crude Calculations Rashonda Williams, responsible for global asset allocation at a large pension fund, gazed at the Blue Ridge Mountains from her Crozet, Virginia, home office. Her task today was to decide whether and how much of her fund should be allocated to oil. At this point—March 2018—there were many reasons to think about adding oil to her fund. One was that oil prices, after falling sharply from the $ 100-per-barrel level, had doubled from their 2016 lows (Figure 1). Was the increasing price over the past few years the beginning of a longer-term trend? At above $ 60 per barrel, was oil now a good buy? Figure 1. Brent and WTI crude oil prices: 2007–Feb. 2018 (in dollars per barrel). The oil price was much lower than in mid-2014, but Williams knew that central banks in many developed countries were still trying to reflate—and those that were not, such as the US Federal Reserve, had begun tightening only because they believed their economies were recovering—so a sustained surge in oil demand, and hence oil prices, was eminently possible. And she knew, having heard of “peak oil,” that even with impressive increases in US supply, supply was not limitless. A possible surge in demand coupled with limited supply—a supply that might be even more limited if the Organization of the Petroleum Exporting Countries (OPEC) stuck to its agreed to production cuts—meant that oil might be an attractive investment. At the same time, so many other asset classes looked less than attractive; bond prices seemed to have nowhere to go but down; and equities looked expensive. . . .