What’s next for oil prices?

With fears over global economic growth unsettling investors, the price of oil has taken a hit lately. John Stepek asks if low prices are here to stay.

It's been a pretty grim week for markets.

We had the usual rumblings in the eurozone, with panic over Greece and Spain.

Meanwhile, Chinese economic data was weak. Export and import data missed expectations, as did figures for investment, retail spending, and industrial production.

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On top of all that, JP Morgan has just lost a couple of billion down the back of the sofa.

No wonder investors are rattled. There is an upside to all this though oil pricesare dropping back.

Will this last? And can you profit from it?

Fears over global growth are hurting oil

Oil is a risk-on' asset. When investors turn bullish on the global economy or decide that there's more money-printing coming from the Federal Reserve they push the price up.

But this has been a decidedly risk-off' couple of weeks. And little wonder. Europe is a mess. Investors keep getting ugly reminders of this fact every time they start to relax about it.

There are two sides to the Europe story. We all tend to focus on the euro because it's the big political story, and there's also the fear over what might happen to the financial system if one country decides to leave.

However, there's also the story of the real' economy beyond the financial system. And that's just grim. The fact is, pretty much regardless of what happens to the euro, much of Europe is in a vicious recession, and it'll stay that way. None of that is good for global demand.

On top of this, China's latest economic data is pointing to a slowdown that most investors still don't quite seem to be taking on board. As we noted yesterday, figures for exports and imports were worse than expected.

This morning, data on industrial production missed expectations. In April, industrial output was up 9.3% on last year, compared to 11.9% growth in March. That sounds perfectly reasonable, until you realise that the forecasters had been expecting a rebound to 12.2%. It's also the slowest growth rate seen in nearly three years.

So there are plenty of reasons to be concerned about growth. It makes sense that this will have an impact on energy demand, and therefore oil prices.

However, it's not just a demand story. At the moment, the oil supply just doesn't look that tight. Last week, US crude stockpiles rose to their highest level in over 20 years. Meanwhile, fuel demand was down 0.8% on the year before.

Saudi Arabia has also been going out of its way to talk down the oil price. Petroleum and Mineral Resources Minister Ali Al-Naimi told Japanese reporters that "there is a surplus of oil in the market," reports Reuters. He emphasised that he doesn't expect sanctions on Iran's oil exports to have a major impact on supplies.

The joker in the pack

In short, there's plenty of the stuff around. So is oil set for a big fall? Based on the fundamentals, I think we could see a decent-sized fall from here.

There's just one big problem: Iran. More than anything else, the oil price has been propped up by geopolitical fears. And although these have dropped off the front pages, they haven't gone away at all. As my colleague Matthew Partridge pointed out yesterday, the question of Iran's nuclear ambitions still hasn't been resolved. If there's a flare-up in tension over the region again, then the oil price could easily bounce back.

On top of that, there's another dispute bubbling under, that's worth keeping an eye on. China is currently engaged in a row with the Philippines over an island in the South China Sea. I'm not saying that war is about to erupt in the region, but the Chinese media are taking a pretty aggressive tone. And it's not ideal timing given the wobbly state of the Chinese economy and the political upheaval.

This clearly wouldn't have the same direct impact on oil as a battle in Iran. But it certainly wouldn't help geopolitical tensions.

So while shorting the oil price from here via a spread bet or an exchange-traded product could be profitable, it could also backfire in quite a spectacular manner if you're not careful.

So what should you do?

The spectre of tension in Iran could also keep oil prices where they are for quite some time. So if you're not inclined to short the oil price (and I don't blame you), it might make more sense to look elsewhere in the energy sector.

We've been keen on natural gas producers for some time. The price of their particular commodity is already at rock bottom levels. But another neglected fossil fuel could be worth examining too coal. With the promise of a nuclear renaissance looking ever further away, countries around the world are going to have to look at other options for ways to keep their electricity grids running, and coal will play a bigger part in that than most people realise. My colleague James McKeigue looks at potential plays on a recovery for coal in the latest issue of MoneyWeek magazine.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.