A sneaky oil boom is getting underway

The price of Brent crude hit a two-year high yesterday. John Stepek looks at what that might mean for the global economy – and for inflation in particular.


The price of North Sea oil hit a two-year high

The market has a marvellous sense of comic timing.

In the last few weeks, the papers have been full of talk about how Norway's sovereign wealth fund is looking at extricating itself from the oil sector.

Now if you ask me, that's sensible. Your entire economy runs on oil. Why stick your savings into that mix as well? But of course, the angle in the papers has been: "Is this a sign that the fossil fuel era is over?"

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Divestment, electric cars, lithium, renewable energy it's all the rage.

Which, of course, makes this the ideal time for the price of oil to rocket...

The oil price just keeps ticking higher

The price of Brent crude the European oil price benchmark (the US uses WTI) shot up yesterday to its highest level since 2015.

The latest spike in the oil price was the result of the UK's key North Sea pipeline system, the Forties Pipeline System, being shut down for emergency repairs by privately-owned chemicals giant Ineos (its new owner).

The system "delivers almost 40% of UK North Sea oil and gas production", notes the FT. So it's probably not the ideal time to have it offline, what with the bitterly cold winter conditions now setting in. And it's due to be down for several weeks.

The price of Brent crude oil jumped to a two-year high of nearly $65 a barrel. And the effect on the wholesale gas price was far more drastic it shot up by nearly 30%.

Now clearly, this is partly a local story. The gap between Brent and WTI surged in other words, US oil didn't rise in price by as much. But it did rise.

And the interesting thing is that this wasn't really supposed to happen. US shale oil was meant to be keeping a lid on things. And certainly, US production has gone up rapidly this year, jumping by more than 25%.

But what if that's not going to continue? What if companies that skirted bankruptcy decide that they now only pump as much as the market will bear? That the marginal stuff is best left for higher prices? That they'd rather pay down their debts and enjoy a bit of breathing space?

What if they need prices to be a good bit higher than they are today before they even think of re-opening the floodgates?

As Reuters reports, US shale producers were very pleased by Opec's recent decision to extend its production cuts to the end of 2018. At the end of the day, they're all on the same side in some ways. If the shale giants could legally join Opec, you can bet they'd find a way to do it.

And the chairman of one of the biggest shale producers argued that "extra cash from higher prices should go to shareholders, not fresh drilling", lest there be "another price collapse by the end of 2018."

Dividends, not drilling. It seems the shale industry is maturing from a high-tech boom business where capital goes to die, into one where the incumbents circle the wagons, demand tougher regulations, and look to turn their treasure horde into proper profits.

That's an interesting idea. And quite an appealing one for investors, I should imagine.

In any case, this all comes at a good time for investors who like bargains. I mean, in this market, the idea of a bargain is highly relative Royal Dutch Shell is trading near an all-time high, for example.

But compared to valuations pretty much everywhere else, the energy sector remains fairly inexpensive. As Jim Paulsen of Leuthold Group notes in the FT, "the sector is widely under-owned and represents a contrarian play with a positive potential catalyst from higher oil prices."

We'll be looking at some promising oil plays in Latin America in the next issue of MoneyWeek, out on Friday. (If you're not already a subscriber get your first four issues free here).

The inflation danger

The other issue here, of course, is inflation. And not just inflation, but broader expectations for how high it might get.

Oil has steadily dropped down the global "worry" pile over the last 18 months or so. When the price crashed, everyone worried that US shale producers would go bankrupt. Then, when that didn't happen, everyone relaxed and started to remember that low oil prices are pretty good news for most big consumer economies.

Since then, oil has been seen as a worry for the likes of Saudi Arabia and Russia, but not such a big deal for everyone else.

But with the price rising steadily again, that might change. Oil has a complicated impact on the economy. When the price goes up, it hurts demand - put very simply, consumers spend more money on petrol, so they don't have as much to spend in the shops. But it also drives up costs, so it pushes inflation higher too.

As my colleague Dominic has pointed out on a couple of occasions, oil has been in a stealthy bull market. But much more of this, and it won't be quiet any longer.

Could fear of rising prices and a belief that things will cost more tomorrow than today be enough to tip the balance towards a more inflationary economy? We'll soon find out.

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.