A dip in the oil price could be very bullish for stockmarkets

Major oil producers may soon raise production. That could drive the oil price down, deflect inflation, and boost stocks. John Stepek looks at how likely that is to happen.


Oil production could rise.. and prices fall
(Image credit: © 2015 Bloomberg Finance LP)

Amid all the panic over Italy, you may not have noticed that another very important price has been falling sharply in the past few weeks.

Oil (as measured by Brent crude) just managed to poke its head above $80 a barrel last week.

But since then, it's taken something of a hit.

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So what's going on? And will it last?

Will the Saudis and Russians start pumping more oil?

The price of a barrel of crude oil has fallen as low as $75 a barrel (Brent) and about $65 a barrel (WTI, the US benchmark) over the past week, although it rallied a little yesterday.

It's not a dramatic slide, but it was a pretty quick one and it's certainly called a halt for the moment to oil's sprint higher. And no, it's not all down to the panic over the political situation in Italy.

Russia and Saudi Arabia both suggested last week that they might start pumping out a bit more oil. Given the apparent success of their strategy to cut production, this might seem odd.

However, as far as Russia and Saudi Arabia are concerned, they are just making up for (and profiting from) the shortcomings of their fellow cartel members, rather than boosting production overall.

That's because Venezuelan production has collapsed precipitously (that's the power of glorious socialist authoritarianism for you), while the reimposition of US sanctions threatens the supply from Iran.

Of course, not every Opec member agrees with the idea of the two biggest players (Russia isn't a member, but it might as well be for the purposes of this discussion) ramping up production again.

Venezuela is one (if you can't boost your production then you certainly don't want anyone else to, in case it drives down prices). Iran is another (for similar reasons US sanctions mean it can't sell as much as it briefly could). So they have nothing to gain.

Energy ministers from Saudi Arabia, the UAE and Kuwait are now planning to have a meeting on Saturday to have a chat about it all. There is then a big meeting in Vienna on 22 June, at which all Opec members and Russia will discuss the issue and agree on a course of action, one way or another.

So is the added production likely to happen?

Well, there are two good reasons for raising production, at least from an Opec producer point of view. Firstly, the Saudis have probably learned their lesson from last time. If the oil price goes too high, it gives the people who buy your product a good reason to find alternatives.

The shale-oil horse has already bolted, but people are still not entirely convinced that electric cars are the near-future if the oil price goes back above $100 a barrel, they might change their minds.

Secondly, shale producers are here to stay. If the Saudis and Russians don't ramp production up to meet demand, then their arch-rivals in shale oil will do it instead. And that would only make their position even stronger.

That said, both Saudi Arabia and Russia will have noted the major impact that even discussing an increase in production has had on oil prices. Other Opec members won't be too happy about that, and it may also have unnerved the main players.

Given the rare success of the production cuts (rare in that those involved actually stuck to the agreement for a prolonged period of time), then maybe they won't want to upset the apple cart.

A lower oil price could be good news for markets if they can get over Italy

So what does this mean for your money?

Regardless of what happens with production, oil has been on a real tear recently, and had probably run ahead of itself. As a result, it didn't take a lot of bearish news to knock it off its perch. The mere mention of production increases was enough to do it.

Secondly, the market is in "risk-off" mode because of Italy, which will put a dampener on most markets, including oil. So the reality is that in the short term, the oil price is likely going to struggle for a bit almost regardless of what the Saudis and Russians do.

I doubt that oil is going to fall far, if at all. But it may have found a range for the time being.

If that's the case, then the sorts of stocks and markets that get crushed by rising oil prices transport stocks, the Indian market, the Japanese market (to an extent) won't be under as much pressure now.

Better yet as far as investors are concerned if oil prices behave, then short-term inflationary pressures will dissipate somewhat. That gives the US Federal Reserve in particular a bit more breathing space, and we all know that markets love the idea that interest rates are going to stay lower for longer.

In effect, a stable or gently falling oil price would be equivalent to looser monetary policy. If a less feverish oil market means markets start to think the Fed won't move as fast, then on balance, you'd expect that to be good for stocks.

Of course, as we've already pointed out, a lot of this is moot while Italy is still roiling the markets. A proper, full-blown eurozone crisis would turn into a banking crisis, and as we've learned by now, banking crises are deflationary. If that potential black hole opens up again, markets in general aren't going to like it falling oil price or no.

On 14 June the European Central Bank meets up to discuss quantitative easing. That's the big meeting to watch for now.

But if markets can get over the Italy hurdle, then a bit of leeway on oil prices could be just what they need to turn bullish again. I stress that this is not a prediction but it is a scenario to be aware of at a time when it's tempting to embrace full-blown apocalyptic thinking.

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.