21 March 2012

The oil price is the new eurozone crisis

No sooner has the pressure on markets from the eurozone crisis begun to ease than investors have found something else to worry about – the oil price

By Tom Stevenson | The Telegraph | 17 Mar 2012
A chapopero, literally the tar man, shows his oil-covered hands after cleaning a waist-deep pond of spilled crude oil in La Venta, Mexico,An oil price spike is never welcome but it would be particularly damaging with the global economy in such a weak state Photo: AP

If, as they say, bull markets “climb a wall of worry” then the seamless shift from fretting about Greece to today’s focus on Iran may be no bad thing. But with the memories still fresh of what the rising price of crude did for the global economy in 2008 and 2011, it is hard to be too relaxed. There are a number of reasons why the oil price has pushed above $120 for a barrel of the costlier Brent variety. Stocks are low and production has been below expectations in a number of countries around the world. Libya has only partially restored production, Syrian output is under embargo, while conflict has pared production in Yemen and South Sudan.

Against this backdrop of tighter supply, emerging market demand is increasing each year at an incremental 1m to 1.5m barrels a day. To that can be added the impact of quantitative easing, which, by raising the supply of paper money, increases the relative price of more reliable stores of value like oil. Throw in geo-political uncertainty and the recipe is in place for a persistently high and probably volatile oil price for the foreseeable future.

The situation in Iran is the market’s particular worry at the moment and it is not hard to see why, given the casual manner in which the prospect of an Israeli strike on Iran’s nuclear capability is being discussed. A particularly sobering piece of analysis from Nomura this week calmly pinpointed the most likely date of an attack. The likelihood of an early Israeli poll and the timing of the US Presidential election suggest September is the date to pencil in your diary.

What might be the consequences of such an attack? The first is obvious. A spike in the oil price would be inevitable, especially if supplies through the Straits of Hormuz were restricted and insurance on vessels entering the Gulf was withdrawn. The Iraqi invasion of Kuwait saw the price of oil double in 1990, albeit briefly, and last year’s Arab spring pushed prices sharply higher.

Other consequences might be less predictable. As well as a likely increase in terrorist attacks on US and other Western targets, Nomura points to the increasing instability of Iraq following the US withdrawal from the country. A slide towards civil war is a non-trivial possibility if Iran and Saudi Arabia decide to face up to each other by proxy in the country.

An oil price spike is never welcome but it would be particularly damaging with the global economy in such a weak state. Only the US is looking remotely secure on the path out of the financial crisis. Both China and Europe are struggling to regain the growth rates they enjoyed before 2008. A high oil price would temper economic growth via higher petrol and other fuel prices. And it would lower consumer confidence and disposable income, most notably in the oil-intensive US.

It all feels worryingly like a re-run of 2011, when a combination of the Japanese earthquake and pricier oil knocked the nascent economic recovery on the head. In 2008 too, and acknowledging the more important impact of the Lehman-inspired credit crunch, oil was a contributory factor in that year’s recession.

What does this mean for investors? Interestingly, a higher oil price does not necessarily translate into lower share prices. It all depends what the reason for the price spike is. HSBC has analysed 11 periods of rising oil prices over the past 40 years and concluded that equities usually rise along with oil. That’s because oil typically rises in response to stronger economic growth, which also, of course, leads to higher share prices. The exceptions are the price spikes associated with supply shocks such as those in 1973, 1979 and 1990. Even here, though, comparisons need to be made with care because the global economy has become a lot more energy efficient in recent years.

Clearly today’s oil price is a consequence of a mixture of drivers, some positive (emerging market growth, US recovery) and some negative (Iran, QE, supply shortages).

What should investors do? Given the likelihood that the oil price will stay high, with the risk that it could spike higher still, a sensible approach might be to err on the side of defensive stocks, including those underpinned by high and sustainable income, and to increase exposure to the energy sectors and energy exporting countries.

Tom Stevenson is an investment director at Fidelity Worldwide Investment. The views expressed are his own. He tweets at @tomstevenson63
© Copyright of Telegraph Media Group Limited 2012

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