How is Russia's economy doing?

Before the Iran war oil shock – meaning a jump in oil prices and a jump in revenues for the Kremlin – things were looking as bad as they have done since Russia's invasion of Ukraine in February 2022.

At that time, many Western politicians and economists expected Russia's economy to collapse under the pressure of sanctions and fiscal implosion. “The Russian economy is on track to be cut in half,” said then US president Joe Biden a month into the war. “It was ranked the 11th biggest economy in the world before this invasion – and soon it will not even rank among the top 20.”

How wrong was Joe Biden about Russia?

Very wrong. By 2025, Russia had nudged up the table to become the ninth biggest economy globally, overtaking Canada and Brazil, and lying just behind the UK, France and Italy. In response to sanctions, Russia ramped up state spending on its war machine, driving an unlikely economic mini-boom, and predictions of collapse proved wide of the mark.

A shallow recession of 1.4% in 2022 was followed by solid positive growth in 2023-2024, partly facilitated by high oil prices and partly fuelled by the rise in war-related spending and corporate credit growth. The fiscal position deteriorated, but remained in relatively safe territory, while a consistent current-account surplus “helped soften the impact of approximately half of Russia's international reserves being immobilised”, explains Marek Dabrowski of the Bruegel think tank. All told, the post-2022 Russian economy demonstrated striking resilience.

How is Russia's economy so resilient?

Essentially, Russia has resources and products that other countries want to buy. If the price is right that trade will happen, albeit with Russian oil and gas trading at a discount to pre-war prices. Western sanctions, which have in any event been supported by nations making up less than half the world's economy, were too telegraphed, slow, and easy to circumvent via third countries, given the weak enforcement of secondary sanctions. And China's role in ramping up Russian imports and exports was crucial: it has taken the place of Europe as Russia's biggest trading partner.

Second, the Russian regime was ready for war. It had planned for sanctions for years, stockpiling dollars, and when the crunch came it forced many foreign companies to sell their Russian entities at low prices. And third, the de facto creation of a war economy has not only fuelled growth, but also entrenched a network of supporters of the regime among the business class.

Is Russia's economy a war economy?

Over the past four years, Russia's economy has been growing, but only because civilian industry has been “progressively cannibalised” to feed dramatically ramped-up military production, say Emma Sage and Savannah Taylor on War on the Rocks. Germany's foreign intelligence believes that the war accounts for 10% of GDP and for more than 50% of government spending. Russia's Centre for Macroeconomic Analysis and Short-Term Forecasting attributes 60%-65% of Russia's increased industrial output from 2022-2024 to the sectors most implicated in the war on Ukraine, while showing that unrelated industries are declining. Meanwhile, domestic consumption is underpinned by Smertonomika, or “Deathonomics”, whereby wages for soldiers willing to brave the war – and compensation payouts to their families when they are killed – have soared. Pay for soldiers is six times what it was in 2022, while death payouts have risen to the equivalent of $130,000-$180,000 – more than the expected life earnings of many of the young men who die. In short, Russia has mortgaged its future to pay for the war. Eventually, that will have to be repaid.

What is the current situation in Russia?

Stagnation has set in and the government is $320 billion in debt. Growth fell sharply last year from 4% in 2024 to less than 1% in the fourth quarter of 2025. This week Russia's president, Vladimir Putin, announced that GDP declined 2.1% in the year to January, with industrial production also falling by 0.8%, even as unemployment remained low at 2.2%, while inflation stood at below 6%. Many Western analysts suspect the reality is worse. The economy will not collapse, says Alexandra Prokopenko in The Economist. “But nor will it recover. It has entered what mountaineers call the death zone: the altitude above 8,000 metres at which the human body consumes itself faster than it can be repaired.” Russia is sustaining a “negative equilibrium”: it has the ability to hold itself together at the cost of steadily destroying its own future capacity. Export revenues are falling and economic weakness means budget gaps cannot be filled with additional tax revenues.

Will the Iran war rescue Russia's economy?

Obviously no one knows how long the oil price will remain elevated from its pre-war levels. But Putin himself – sometimes touted in recent weeks as the “real winner” of the conflict – isn't exactly celebrating the dawn of a free-spending new paradigm. This week, he called on oil and gas companies to use additional revenues from the current rise in global hydrocarbon prices to reduce their debt burden and repay obligations to domestic banks. Clearly, Russia is a beneficiary of the conflict in the Persian Gulf and Middle East, with higher prices and (perhaps) higher export volumes to Asia able to narrow its budget deficit. “But unless disruption to global energy supplies is prolonged, this is unlikely to materially alter Russia's macroeconomic outlook,” says Liam Peach of Capital Economics. The country will remain a war-driven, low-growth, low-productivity economy that's dependent on hydrocarbons – a waning resource in the long run – and under chronic fiscal pressure. “Russia can probably continue waging war for the foreseeable future,” says Prokopenko. “But no climber can survive the death zone indefinitely – and not all climbers who attempt the descent survive it.”

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As the oil crisis gathers momentum, it remains to be seen how events play out in the Persian Gulf – a ceasefire might be agreed with Iran and the shipping lanes might start to reopen, as might the production facilities. But as the week started, it did not seem likely. Oil spiked over $100 a barrel, and across Europe, natural-gas prices more than doubled. By Tuesday morning, they had started to fall again. And in real terms, $100 is not in any cases all that extraordinary a price for oil. The real-terms price was $131 in 2008 and $104 after the start of the Ukraine war.

Still, the rise is already pushing up costs across Europe and Asia. And it is Britain that will be hit hardest of all. Twenty years of deluded policymaking is about to be brutally exposed if oil stays at these levels. Why? Firstly, the UK is critically dependent on imported energy. We have been steadily running down domestic production in the North Sea with a punishing mix of windfall taxes and bans on new exploration, while assuming that wind and solar power would make up the shortfall.

That has not happened and it has cost far more than anyone expected. Instead, we rely on massive imports of natural gas to keep the power stations running and imports of oil to keep the petrol pumps open. As it happens, Britain does not import huge amounts of gas from the Middle East, but we still have to pay the global price. If we had our own production, not only would it increase global supply (and therefore reduce the price, at least marginally), but more importantly, in a crisis, the government could always requisition supplies. As it is, when prices go up, we feel the full brunt of it.

An oil crisis will lay waste to British industry

Secondly, an oil crisis will lay waste to industry. What remains of manufacturing was already getting hammered by industrial energy prices that are twice those of France and four times the US's. Car output has fallen back to levels last seen in the 1950s, as has cement production. Huge swaths of the chemicals industry have closed down. With oil and electricity prices almost doubling, what remains will be in deep trouble.

Many manufacturers that were just about breaking even will now have to close and the damage will quickly spread to retailers, cafes and restaurants if their power prices go up as well. Business was in bad shape already. This will finish many of them off.

Thirdly, we rely on massive amounts of foreign borrowing. The rising oil price has already led to a sharp rise in gilt yields. The government's finances will be in worse shape than ever and that is before ministers panic and launch a bailout to try to control the price rises. Almost a third of the £100 billion-plus the UK has to borrow every year comes from overseas. If there is a general sell-off of government bonds, and that is looking more and more likely all the time, then the UK will inevitably be right in the centre of the storm. Sterling is a big enough currency that it can be traded in volume, but not so big that its central bank can control the market. We can be sure the hedge funds will be shorting gilts and sterling if sentiment turns against the UK.

Stagflation is our best hope

Finally, the government was banking on falling oil prices to have any hope of growth. The only real plan that remained was for the Bank of England to steadily reduce interest rates as inflation came under control, reducing mortgage rates and stimulating demand. Chancellor Rachel Reeves kept boasting interest rates coming down were one of her major achievements. In the wake of the oil-price spike, traders have cut the chances of another cut from the Bank this year to zero. Worse, rates might even have to rise if prices spike upwards. With taxes rising at the same time, and unemployment going up as well, stagflation is the best we can hope for. By the autumn, the UK may have tipped into a full-scale recession.

In short, a government that has already sunk to 20% or less in the polls is going to be in deep trouble. It did not have much of a plan for kick-starting growth or for improving living standards to start with, but what little hopes it may have had for the economy have now been dashed. Its own policies have been making the energy crisis worse, not better. An oil crisis is the last thing Labour needs this year. It will painfully expose all the frailties of the British economy – and right now it looks as if it may be too late to do anything about it.

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It is not easy to say what the Iran crisis means for markets, not least because it changes hourly. I write this on Wednesday; by Friday, anything could have happened, as Monday's near-$30 swings in the oil price have shown.

The logical assumption is that the Iran crisis will pass and energy prices will fall back. This has been the pattern in Middle East upheaval for at least a couple of decades. In that case, there is not much to be gained from fretting about short-term swings. For most of the last two weeks, this has been the consensus among investors. Markets have been much calmer than you might predict, with a few exceptions, such as the pullback in Korea, which has been flying of late. Ignore the hyperbolic headlines about “tumbling” and “plummeting” on drops of 3% or so: stocks have not been panicking so far.

Still, we can think of cases where the impact did not pass quickly (eg, Russia's invasion of Ukraine and, indeed, various events in the Middle East longer ago). That scenario favours US markets and the US dollar over most of the rest of the world in the short term. The US has greater energy security – it is a net oil exporter, and high prices will encourage shale oil producers to boost output. This is already being reflected in markets: the dollar is slightly stronger and US stocks are performing better.

With that in mind, note that while non-US stocks beat the US last year, it was only in the US where earnings met expectations, points out Paul Niven of F&C Investment Trust (LSE: FCIT). Investors who have run up European shares are keen to see growth come through. The longer the crisis goes on, the less likely that is and the more scope for market setbacks.

Three reasons to fear the Iran crisis becoming a longer war

The obvious reason for optimism is that prolonged disruption to oil exports will benefit almost nobody. Yet if you want to be a pessimist, the three main participants may feel otherwise. Iran could have an incentive to maximise disruption this time because it will make the cost of attacking it again in future seem much higher. Israel might want to continue until Iran's government falls and its military capabilities are destroyed.

The US gains nothing from a protracted crisis that keeps oil prices high, but it seems to have started this fight without a clear plan for finishing it. Markets took Donald Trump's comments about the attack being “pretty much over” as reassuring, but perhaps they should have been spooked by clear signs of an erratic president who did not seem to be in command of the facts.

So the outcome is anybody's guess. All we can say is that the world keeps looking more volatile. There have always been financial shocks (“markets climb a wall of worry”, as the adage goes), but the key difference today is that the geopolitical framework in which we invest is becoming more less stable. One key implication of this is that inflation will be more volatile because supply chains are more easily disrupted. Inflation protection – real assets and stocks with pricing power – will be increasingly important.

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The war in Iran is keeping the price of oil incredibly high. The commodity reached a recent peak of $110 for a barrel of Brent crude on 4 May, potentially meaning higher prices for your petrol, food, and even your mortgage.

While prices calmed down through the week, reaching around $100 a barrel on 8 May, they remain far higher than before the war as the supply of the vital material is still heavily constrained.

The Iran war has led to increased uncertainty for the oil trade as it has become less safe to extract and ship oil from the Middle East to the rest of the world.

The threat of missile strikes from either the US or Iran means there is a highly increased level of risk involved in the trade.

On top of this, the Strait of Hormuz, a narrow waterway between Iran and Oman through which around 20% of the world’s oil is transported, has remained shut since the war began on 28 February.

As supply has been disrupted while demand has remained the same, the price of the commodity has soared, rising from around $73 on 27 February to $100 on 8 May, an increase of nearly 37%.

One of the clearest consequences of this has been on prices at the pump but, as oil is vital in the manufacturing process of many goods we consume every day, a rise in the price of oil has led to a general increase in inflation.

The latest data from the Office for National Statistics (ONS) showed inflation jumped to 3.3% in the year to March, an increase of 0.3 percentage points compared to the year to February.

With inflation on the rise, households will start to see their budgets stretch and it could mean their savings are eroding in real terms if inflation is higher than their interest rate.

We look at why oil prices are rising and what it could mean for the UK economy, interest rates and fuel prices.

Why the conflict in the Middle East has impacted oil prices

There are two key reasons why the price of oil has increased due to the war.

The first is that the conflict is bad for business. A great deal of the world’s oil is extracted from countries near Iran and war in the region means it becomes much more risky to continue normal operations.

In the first days of the war this was made very clear, as Iran fired retaliatory missile strikes on many countries in the Middle East, including the United Arab Emirates, Oman, and Cyprus, among others.

The second is that Iran (and later the US) was able to halt traffic through the Strait of Hormuz and hurt the world’s oil supply by effectively blocking 20% of it from being transported and stranding oil tankers in the Persian Gulf.

While the oil supply has reduced, the demand has remained the same, meaning the price of oil has increased.

But it’s not just oil that has had its supply constrained thanks to the war. Other goods are also impacted.

One example is fertiliser – around 30% of the world’s supply is shipped through the strait. Like in the case of oil, lower supply and steady demand have meant fertiliser prices have increased, which could lead to increased food prices later on.

Where prices go next will largely depend on how long shipping will be disrupted for.

How does the oil price affect the price of petrol?

One of the most direct consequences of higher oil prices is the impact on what you pay at the pump, given that oil is vital in the manufacture of petrol and diesel.

Before the conflict began, the average price of a litre of petrol was 133.8p (142.3p for diesel).

But between 28 February and 8 May, the average price of a litre of petrol has increased by 24.3p, while diesel has increased by 46.5p, according to RAC Fuel Watch.

That means the average price of a litre of petrol is now 157.6p (187.9 for diesel). That is a significant increase, but it does not exactly mirror the extent that oil prices have risen in the same period.

This is because more than half the price of a litre of petrol is tax. Fuel duty accounts for around 34% of what you pay at the pump, while VAT accounts for a further 17%.

The price of the oil itself only accounts for 34% of the price of a litre of petrol in the UK. In theory, that means a 10% rise in global oil prices might increase the price of petrol by around 3% or 4% (though it isn’t necessarily that straightforward in reality).

Could higher oil prices increase inflation?

While petrol and diesel prices are some of the fastest to react to the increased price of oil, that does not mean they are the only costs that will increase.

Oil is used in the manufacturing process of many goods we consume each day. This includes goods as varied as plastic, crayons, shoes, backpacks, iPhones, pillows, and much more.

With oil being more expensive, the overall level of prices in the UK is also higher.

The latest data from the ONS showed that inflation was 3.3% in March, and most analysts estimate that price growth will continue to increase.

Economists at the Bank of England think inflation could reach a peak of around 3.5% in the third quarter of 2026.

Much of this increase will come from rising energy prices. These increased energy costs will not only affect households, but also businesses. Firms will likely hike their prices to make up for increased energy costs.

Experts are also warning that the inflation associated with the impact of the war poses a threat to the UK economy.

The International Monetary Fund gave the UK the biggest growth downgrade of any country in the G7 when it published its latest economic outlook, now anticipating the economy to grow by just 0.8% this year.

Meanwhile, with inflation expected to rise again, most economists agree that it will be quite some time before we see the Bank of England cutting interest rates again.

Indeed, the market is currently pricing in interest rate hikes this year, though some economists say that while this is certainly much more of a possibility, it is more likely that the central bank will freeze rates for the foreseeable future.

Read more on the inflation forecast for 2026 in our guide.

Could higher oil prices increase your energy bill?

The conflict is expected to have a significant impact on the next Ofgem energy price cap.

Ofgem determines the price cap by working out the average wholesale price of energy in a three month period, and the observation period for the July price cap will include the war and its consequences on energy prices.

That means that even if the ceasefire lasts and a lasting peace is achieved, much of the damage to energy prices is already baked into the next price cap.

As such, the July to September price cap is expected to reach £1,836 per year – an increase of more than 12%, or around £195 per year, when compared to the current level in place between April and June, according to energy consultancy Cornwall Insight.

“Global oil markets have just become a lot more flammable,” says The Economist. On 13 June, two years of heightened Middle East tension finally boiled over into a full-scale Iran-Israel war. With Iran on the ropes, there is a growing risk that its leadership will resort to “desperate measures”. Tehran might close the Strait of Hormuz, the narrow channel through which 30% of global seaborne crude and 20% of liquid natural gas is conveyed. Worse, many of the Gulf’s largest oil-production sites are within range of Iranian missiles. Such retaliation could send prices soaring above $120 a barrel, according to estimates by bank JPMorgan Chase.

Oil prices surged as much as 12% following the first Israeli air strikes to trade at around $72 a barrel this week. All told, that is a fairly measured reaction, says Henry Allen of Deutsche Bank. Brent crude is still well off its 2024 average level of $80 a barrel. Two brief episodes of Iran-Israel exchanges last year have numbed commodity traders to geopolitical risk.

If anything, the real surprise is “the extent of the market’s resilience to repeated shocks”. So far “not a single barrel has been lost” amid the wave of Middle East violence that began in October 2023, says Javier Blas on Bloomberg. Traders have learnt that shorting crude even as bombs and missiles fly is a “winning trade”.

Oil well supplied through 2030

Geopolitical drama aside, oil markets show every sign of being oversupplied. Global inventories have been running “above seasonal norms” for months. The latest spike may just enable US shale producers to keep pumping profitably at levels that would otherwise not have been possible. Indeed, the global oil market is forecast to remain “well supplied through the end of the decade”, according to International Energy Agency forecasts, reports Giulia Petroni in The Wall Street Journal. Global demand for oil is forecast to rise to a plateau of 105.5 million barrels per day (mbpd) in the coming years, but supply is likely to increase even more to 114.7 mbpd over the same period.

Cooling appetite for oil has much to do with China, says Hans van Leeuwen in The Telegraph. Total demand for oil in the Middle Kingdom is forecast to dip from 18.1 mbpd last year to 16.7 mbpd come 2030 due to mass adoption of electric vehicles (EVs). Chinese motorists purchased two in every three EVs sold globally in 2024. Meanwhile, for British motorists, “every $10 increase in oil adds 7p at the petrol pump”, David Oxley of Capital Economics tells Szu Ping Chan in the same paper. Still, the UK economy is much less dependent on cheap oil for economic growth than it used to be.

In 1975, one tonne of oil equivalent was needed to produce roughly $8,333 in GDP according to World Bank figures, says Gillian Tett in the Financial Times. In 2022 the same amount of oil generated $20,000 of GDP. An “oft-ignored” good news story is that greater energy efficiency and new energy sources are making us all less vulnerable to oil-price shocks than in the past.

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A “boy-who-cried-wolf mindset” has set in on energy markets, says Matt Egan for CNN. Traders, caught out by previous false alarms, have become increasingly “numb to the cascade of crises” afflicting the world – a growing war in the Middle East is thus not causing the oil market the panic you might expect. “Pre-shale revolution, this type of situation would have sent prices well above $100” a barrel, says Helima Croft of RBC Capital Markets. Still, as Bob McNally of Rapidan Energy Group puts it, “the story of the village boy who cried wolf did not end well – for the village or the boy”. While markets aren’t yet panicking, they are feeling nervous following comments from Joe Biden that Israel discussed striking Iranian oil facilities in retaliation for last week’s missile attack. 

Brent crude prices topped $80 a barrel recently for the first time since August, before easing back mid-week, say Rafe Uddin and Jamie Smyth in the Financial Times. Oil rose 8% last week for its biggest weekly gain since the start of last year, and has climbed almost a fifth since hitting a year-to-date low last month. Iran accounts for roughly 2% of global crude exports, or two million barrels per day (mbpd), says Anthony Harrup in The Wall Street Journal. 

A six-month halt to that supply could see Brent “temporarily rise to a peak of $90”, assuming other oil producers step in to fill some of the shortfall, say Goldman Sachs analysts. In the short-term, markets will need to put more “risk premium” on oil – the extra paid to cover the risk of supply disruptions, says David Oxley of Capital Economics in a note. “Depending on how things pan out, this “could conceivably” be in the order of “another $20 a barrel to oil prices”.

Why is there a high supply of oil? 

One reason for the market’s relative calm is that there is plenty of extra oil sloshing around, says The Economist. The Opec+ grouping of producers is collectively sitting on more than five mbpd in unused production capacity, which it has been withholding to prop up prices. That is “more than enough to make up” for any eventual loss of Iranian crude. But the situation is fragile. A regional conflagration could see Iran close the Strait of Hormuz, the shipping lane through which 30% of the world’s seaborne crude oil flows. That could send prices surging toward triple digits. For all the excitable talk, Opec quietly abandoned its quest for $100 a barrel oil in June, says Javier Blas on Bloomberg. 

In view of global oversupply heading into next year, “given a binary choice between $100 and $50 for next year, I’d take the latter bet”. As a rule of thumb, a 5% rise in oil prices adds approximately 0.1% to inflation in advanced economies, says Roger Bootle in The Telegraph. That is much less than during the 1970s energy crises, when Western economies were more “oil intensive” than they are today. These price rises, therefore, don’t yet represent a major inflationary risk. Indeed, given weak global oil demand and rising supply, “over the next year the likelihood is that oil prices will soften”.

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War, peace, or something more chaotic? Oil prices have been volatile, with Brent crude spiking to $114 a barrel on Monday on reports of shooting between the US and Iran in the Strait of Hormuz, only to drop below $103 on Wednesday after secretary of state Marco Rubio announced that the US-Israeli offensive against Iran is over.

Markets are pessimistic that the strait will be unblocked any time soon. Two weeks ago, online prediction markets gave 90% odds that traffic would be back to normal by the end of June, says John Authers on Bloomberg. That figure has now fallen to even odds. Similarly, Brent crude futures are pricing in $90 a barrel for the end of the year, the highest since the conflict started.

Why did UAE quit Opec?

Oil markets won’t normalise before the end of the year at the earliest, says Stephen Innes of SPI Asset Management. But on a longer view, news of the departure of the United Arab Emirates (UAE) from the Organization of the Petroleum Exporting Countries (Opec) suggests that we may be heading for “a more competitive, more liquid, and ultimately lower-priced oil market”. The UAE’s exit is a significant blow to the 65-year-old oil cartel, which coordinates to restrict supply and manage prices.

The Iran war has deepened the split between Saudi Arabia and the UAE, major Opec players and the Gulf’s two leading powers, says The Economist. The Emiratis have chafed under Saudi-led restrictions that forced them to keep 600,000 barrels per day of spare production capacity in the ground, a figure that was rising before the war thanks to new infrastructure investment.

The UAE now wants to raise output to fund post-war reconstruction. Abu Dhabi requires a significantly lower oil price ($50 a barrel) for its national budget to balance compared to Riyadh ($90), making it inclined to pump even when prices are low.

The Emiratis calculate that, with the world transitioning away from fossil fuels, it is better to monetise its oil reserves now rather than risk leaving them in the ground, says Kathryn Porter in The Telegraph. Opec was already losing its grip on oil, with non-members such as the US, Canada, Brazil and Norway collectively accounting for more than half of global supply.

However, Opec’s collective action doesn’t just keep prices high, it also helps stabilise volatile energy markets. With that “coordinating mechanism” weakening, oil prices are likely to “overshoot in both directions” in the future.

Cartels always sow the seeds of their own destruction, says John Kemp in the Financial Times. High prices incentivise new supply from members outside the group. That raises pressure on cartel members to keep supply even tighter, opening internal “fissures”. “Every cartel eventually ends in failure” and “Opec is likely to prove no different”.

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Oil prices have risen sharply since the outbreak of the conflict in Iran, and the chances are that you’ve felt the consequences in your portfolio as well as at the pump. But some investments can offer at least a measure of protection against higher oil prices.

Brent Crude oil futures have closed above $90 every day since 11 March, with the conflict in Iran having effectively closed the Strait of Hormuz – a critical shipping lane through which around 20% of the world’s oil passes.

“The huge disruption to oil and natural gas supplies in the Middle East over the past three months has materially tightened energy markets near-term,” said Mark Hume, co-manager of BlackRock Energy and Resources Income Trust. “The impact on liquified natural gas exports, primarily to Asia, has been even more pronounced.”

When oil prices rise, some of your other investments are likely to fall.

Given most of the world’s industry relies on oil and gas as inputs, higher oil prices have caused chaos in most stock markets and economies.

But high oil prices aren’t bad news for everyone. Some companies – such as oil and energy suppliers – could profit from higher oil prices.

British oil major BP (LON:BP.), for example, reported on 28 April that its underlying replacement cost profit (a measure commonly used by oil and gas companies that factors out inventory gains and losses) more than doubled to $3.2 billion in the year to Q1 2026.

BP’s profit jump was boosted by higher prices, according to Mark Crouch, market analyst at investment platform eToro.

“In many respects, BP has both absorbed and benefited from the same geopolitical tensions, with volatility once again proving a tailwind for an integrated major,” said Crouch.

Its success saw BP make the list of the most popular stocks among DIY investors using Interactive Investor’s platform during May.

How else can you profit from oil and energy price rises, and compensate for all the increased cost that rising energy bills and petrol prices bring?

The risks of investing in oil

Before going into how to invest in oil and energy you should remember that, as recent events have proven, oil prices are highly volatile.

“Investing [in oil and energy] via an exchange-traded product (ETF) that aims to follow the price can risk being whipsawed,” said Rob Morgan, chief investment analyst at Charles Stanley Direct.

Morgan also cautioned that many investors might already have reasonable oil exposure within their portfolios, if (for example) they hold assets tracking the FTSE 100 which includes several oil majors like Shell (LON:SHEL) and BP.

“It is important to avoid unwittingly doubling up on exposure,” said Morgan.

How to invest for higher oil prices

That said, it could make sense, depending on where else you are invested, to allocate a small part of your portfolio to focused oil investments in order to shield yourself from price shocks and the consequent inflation.

“Energy equities can protect a portfolio in certain inflationary scenarios but can also underperform for long stretches when the commodity cycle turns or policy shifts,” said Morgan. “This is why they should generally only be held in small quantities, for instance up to 5%.”

As well as holding oil price-friendly assets, it is also important to remain diversified.

“Diversification and explicit geopolitical hedges remain essential,” said Daniel Casali, chief investment strategist at wealth manager Evelyn Partners. “These include gold, hedge funds, inflation‑linked bonds, short‑duration sovereign bonds and energy equities.”

If you feel your portfolio could do with a barrel or two of extra oil price exposure, then there are several ways you can add it:

• Oil and energy stocks like Shell, BP or Harbour Energy (LON:HBR). These stocks gained 5.8%,19.8% and 12.5% respectively between 27 February and 27 April.
• Funds or ETFs that invest in oil and energy companies, offering diversified exposure to stocks like these. Some examples are the SPDR MSCI Europe Energy UCITS ETF (LON:ENGE), which tracks large- and medium-cap energy companies in Europe, and the iShares Oil and Gas Production UCITS ETF (LON:SPOG), which has a broader international footprint (nearly three quarters of holdings are based in the US and Canada, with most of the rest hailing from Australia, Japan and Norway).
• An exchange-traded commodity (ETC) can act as a simple way to track the oil price. One example is WisdomTree WTI Crude Oil (LON:CRUP), which offers investors total return exposure to WTI Crude Oil futures contracts.

Additionally, several investment trusts offer exposure to oil and energy companies. These include:

^{Source: theaic.co.uk / Morningstar (as at 21/05/2026 based on latest available published portfolio weights).}

There’s a hurricane “right out there down the road coming our way”, JPMorgan Chase’s chief executive Jamie Dimon told a conference last week. “We just don’t know if it’s a minor one or Superstorm Sandy [which caused $65bn of damage in the US in 2012]… you better brace yourself.” Russia’s invasion of Ukraine means oil is likely to get much pricier, he said. Crude could hit $150-$175 per barrel.

Brent crude reached $120 a barrel this week, having risen more than 50% since the start of the year. The price spike came despite an announcement last week by producer group Opec+ that it would raise output by 648,000 barrels a day (bpd) in July and August, higher than the originally planned 432,000 bpd. The world consumes 100 million bpd of oil.

The decision shows that cartel lynchpin Saudi Arabia is finally responding to US pressure to increase production, say Derek Brower and David Sheppard in the Financial Times. The deal marks the end of a “two-year quota system that has helped oil prices rise almost 500% since the nadir of the pandemic crash”.

Yet the modest Opec+ increase is dwarfed by losses from sanctioned Russian crude, which could total three million bpd by the end of the year, according to the International Energy Agency. And pledges by Opec+ to raise output are all the less compelling because many members are struggling to fill existing quotas. The real increase will be much lower, at about 160,000 bpd in July and 170,000 bpd in August, reckon JPMorgan analysts.

Redrawing the map

Opec+ members together control 55% of global oil production, but the key players are Saudi Arabia and Russia, which together account for more than 20% of global output, say David Rundell and Michael Gfoeller in Barron’s. The pair’s strategic alliance is mutually beneficial, with both enjoying a significant windfall from high oil prices. That explains why Washington has had such a difficult time cajoling Riyadh into raising output.

“Russia’s attack on Ukraine is redrawing the world’s energy map,” say Christopher Matthews, Summer Said and Benoit Faucon in The Wall Street Journal. Energy markets are heading for a “more Balkanised” future, divided into a US-led bloc that won’t buy Russian fuel, an axis of emerging markets experimenting with alternatives to the dollar-denominated energy trade, and Middle East producers that stand to gain by selling to everyone.

But while Moscow is enjoying a windfall now, in the long term it will be forced to grant favourable terms to the few countries still willing to buy its energy, while Western technology sanctions will gradually degrade its ability to pump hydrocarbons, says Daniel Yergin of S&P Global. “Russia’s days as an energy superpower are over.”

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Back in 2016 we learnt a new word on these pages. “Lustrum”.

It means a five-year period. Given how long decades are, I can’t believe it doesn’t find more use.

Even if we don’t use the word, we investors often think in terms of lustrums. Many of the investments we make are made with a three-to-five-year time horizon in mind.

Which is precisely why I started using the word. We had identified a trade of the lustrum. It was oil.

So how’s it doing?

Oil still looks very cheap relative to most other assets

Very well, is the answer. But it hasn’t been an easy ride. At times we have really had to bury our heads in the sands. Crude was in the mid-$30s when we recommended it, but at one stage we found ourselves $60 underwater!

How is that even possible, you might wonder? Well, of course, oil went negative back in 2020.

But like all normal humans when presented with facts they don’t want to hear, we put our hands over our ears, shouted, “blah, blah, blah fishcakes” and went and played table tennis. It won’t last, we thought, and we were right. In fact, we should have bought more.

Our reasoning back in March 2016 was that oil was extraordinarily cheap relative to other assets, be they stock markets, tech stocks, houses, gold, or even other commodities.

It could go lower, we reasoned. Then again it might not. But, we observed, it was an anomaly that it should be trading at the same price it had been in the 1980s given how much money has been printed since.

So here we are six years later, with oil three times the price or more, how’s the trade looking now? Do we sell?

The trade is maturing nicely, I’d say. But, to use an analogy, although the wine in the cellar is getting finer all the time, it’s not yet at its most drinkable.

Let’s consider some long-term ratios, starting with oil vs stocks. This chart shows how many units of the S&P 500 you can buy with a barrel of West Texas Intermediate (WTIC – the US benchmark). Currently you get 0.03 of an S&P 500 unit (4,135) for a barrel of oil ($114).

When the chart is falling, oil is getting cheaper relative to stocks. When it is rising, oil is getting more expensive.

So you can see that it fell through the ‘80s and ‘90s, as the oil price declined, yet it rose through the ‘00s as the oil price made its way from $10 to $150/barrel.

You would expect this ratio to fall over time as oil production techniques improve and stock market valuations increase as economies grow.

Nevertheless, we are nowhere near the “sell” zone. If anything, we are still in the “buy” zone. The ratio is the same price it was in 2002. No reason here to sell our oil and move the money back into stocks.

Call me again when the ratio is at 0.07. That’s another way of saying I see oil getting at least twice as expensive relative to stocks as it is now before this is over.

If the S&P 500 is 4,000, a 0.07 ratio gives you an oil price of $280. Mark my words – $300 oil is not such an outlier.

Here’s WTIC vs the Nasdaq. Again you would expect Nasdaq valuations to improve over time versus oil because of the scalability of digital and the growth in that sector. But on a relative basis, oil again looks very cheap and is still a buy.

Using the ETF VNQ as a proxy for US housing, here is WTIC vs housing since 2004.

It was three times higher before the end of the last bull market.

And finally here is crude against gold – how many ounces can you get for a barrel? The answer is 0.06 of an ounce.

This ratio tends to be much tighter over time – just as oil production techniques improve so do gold mining techniques, and there isn’t the growth-of-companies factor to push it lower.

We are somewhere in the low-to-middle range. Call me when it gets above 0.1. If gold is $1,850 an ounce that would mean oil at $185/barrel.

It’s not just relative – there are strong fundamental reasons for oil to go up too

So we’ve looked at relative valuations. What about the fundamental reasons to expect a higher oil price?

First, there’s 14 years of money printing and inflation. A lot of that money is going to go into the basic human requirement that is energy. Even if they print less, the money has still been created and oil is essential. Unless there is a sudden 2008-style debt destruction moment, that money will remain.

Second, despite the fracking revolution, and the improved productivity it brought about, for almost ten years now there has been huge underinvestment in the sector. From lack of new discoveries through to pipelines, this means higher costs.

Misguided anti-fossil fuel narratives perpetrated across the media and social media have made this sector toxic. Few want anything to do with it. Talent goes elsewhere, and with it investment. So productivity declines.

Governments have exacerbated the lack of investment with their pursuit of green energy and net zero. They clearly don’t get it. The narrative now is windfall taxes. That’s only going to further disincentivize investment. Policy-makers are attacking and blaming this essential industry, not helping it.

The Russian invasion of Ukraine has accelerated things. But this was all going to happen anyway. The hypocrisy of the net zero movement is that it is going to require the burning of one heck of a lot of fossil fuel to make it happen.

Fossil fuels are essential. Demand isn’t going anywhere. Not for a few years anyway.

The latest news out of oil cartel Opec has wobbled the price a little. I’m not concerned. I’m thinking longer term. What was my “trade of the lustrum”, is now my “trade of the decade”.

My preferred vehicle to play oil back in 2016 was, oddly, BHP Billiton (LSE: BHP). Known as a mining giant, something like 22% of its revenue and 34% of its earnings came from petroleum. And if you plot a chart of BHP over WTIC, you would see that one tracks the other quite beautifully.

However, BHP, for reasons stated above, is moving away from the sector. This will further help the oil price of course, but it also means its use as a proxy is no more.

Consider SPOG – the iShares Oil and Gas Production ETF (LSE: SPOG) – as a vehicle.

Another option is the Han ETF – Alerian Midstream Energy Dividend UCITS ETF (LSE: MMLP) – which yields around 6%. It gives exposure to midstream energy companies involved in the processing, transportation and storage of oil, natural gas and natural gas liquids in the US and Canadian markets.

Dominic’s film, Adam Smith: Father of the Fringe, about the unlikely influence of the father of economics on the greatest arts festival in the world is now available to watch on YouTube.

The oil price has had another dramatic start to the week.

Last week, we saw $120 a barrel last week for the first time since 2008. This morning, we saw nearly $140 a barrel for the first time since – yes, 2008.

I’m wondering if we’ll hit a new record next week.

A soaring oil price is bad news for the vast majority of us

Overall, a soaring oil price is bad news for most of us. Soaring oil prices are correlated with recessions for a very good reason – you need only look at your household expenditure to demonstrate why. You fill your car with petrol; the more you spend on that, the less you have to spend on other things.

But beyond that, the price of oil is, at a very fundamental level, the price of raw energy. Everything in our lives is just a transformation of energy. If the price of that goes up, then the price of everything goes up.

So oil sitting at its highest level since 2008 (another correlation with a recession, though the problems then were very different) is really bad news for the global economy.

You might own oil producers or exposure to raw materials, and if you’re a MoneyWeek reader, you probably do, as we’ve been banging on about it enough. From that point of view, the bits of your portfolio that benefit from rising raw material prices but aren’t exposed to Russia have probably done very well.

But that “wealth” effect won’t make it any easier to fill up your petrol tank. You aren’t selling shares in SPOG to fund your trip to the garage.

Combine this with the rocketing gas price, which is going to hurt most people even more, and it’s really not looking good for consumer spending, which in turn means it’s not looking good for the wider economy.

So what’s going on here?

Let’s park the financialised aspects of commodity markets for the moment (though we’ll return to them in a second). The basic problem here, as we discussed on Friday, is simple: Russia is a big oil producer, but Russian oil is now a toxic asset (if you’ll forgive the pun).

It hasn’t been banned as such, precisely because Russia is such a big market supplier. But lots of buyers won’t take it because of the risks attached to it. So you’ve effectively removed a big chunk of oil supply from the market – or at least, made different varieties of oil much more attractive.

This is why Brent crude oil, for example, has been trading at a massive premium to Urals oil, Russia’s main benchmark. Shell managed to buy a cargo of said oil at a near-$30-per-barrel discount to Brent last week, but the flak Shell’s taken for this shows you why most companies are shunning the stuff.

Anyway, the new spike this morning in the Brent oil price was driven by the rumours that the US might impose an outright import ban on Russian oil. That hasn’t been confirmed yet, but, given the moral pressure being brought to bear (and we all know that politicians like a black and white issue to campaign on), it would hardly be a surprise.

What could send the oil price lower?

Is there any potential solution? David Fickling on Bloomberg argues that we might not need to worry. He makes the good point that oil prices averaged about these levels back in 2010 and 2011, which was the tail-end of the commodities boom (prices spiked and crashed in 2008, but bottomed in November 2008 and then rose until about May 2011).

So, while Brent has come a long way from negative territory back at the peak of Covid-19, above-$100 a barrel is not unheard of.

What I’d say though is that this isn’t that comforting for the average UK reader. The pound is outperforming the euro right now, but like every other significant currency, it’s fallen against the dollar, and thus, we’re going to keep seeing record prices at the pump for now. Can anything bring these prices down?

Over time, you’d expect high prices to encourage more oil production, particularly by US frackers. Capital discipline is one thing, but if US politicians start to encourage “patriotic pumping” then I can’t see the fracking companies holding back at these prices.

There are also yesterday’s baddies to consider. The US is talking to both Venezuela and Iran about bringing their oil supplies back into the mix. Iran has been sanctioned over its nuclear plans – I’m not sure that this situation will incline the Iranians to change much, but the US may not care.

And finally, there are strategic reserves to play with. Any release of those will most likely have only short-term consequences (so don’t try to day-trade the oil price, not that you need telling about that).

Some shares are starting to look more appealing now

So what does it all mean for markets? One big short-term risk stems from the size of the moves in commodity markets. These have been so significant and disruptive that you have to imagine that someone, somewhere, right now is looking at a pretty disastrous outcome.

Will a hedge fund blow up? Does a eurozone bank have too much exposure to the commodity trade? A combination of these price moves along with Russia being effectively cut off from the financial system means that accidents are more than possible.

Overall, this isn’t something I’m overly concerned about – central banks have a pretty well-established precedent on what to do about this stuff now. At one point, bailouts were politically tricky and therefore slow to progress. Now, no one is going to bat an eyelid if the Federal Reserve steps in, pretty much regardless.

In terms of your own portfolio, big swings in the oil price like this are disorientating, but they shouldn’t matter on a day-to-day basis. I’d just stick with your exposure to commodity producers, though I also wouldn’t be surprised to see a big sell-off if anything about this situation looks like being resolved (although I’m struggling to see where that comes from).

Where to look for opportunities? One area that caught my eye a bit at the weekend is that consumer stocks are being sold off just now.

That makes sense: rising inflation hurts and rising pressure on disposable income hurts, but it does mean you might find you can pick up consumer stocks you like at better prices than we’ve seen in a while.

For example, I rate Next highly as an unusually competently run retailer. It’s down about 30% from its most recent high, in November last year. Do I think it could go down more? Certainly. Do I think that it’ll be a solid long-term buy if it falls much further? Certainly (it probably already is, but I’m greedy, and this market feels like it has a bit more panic in it).

This is why you have a watch list, prepared for these moments. This is why you don’t panic. This is why you always have a bit of uncommitted cash at the ready. This is why you have a plan.

And if you don’t have a plan, now is the time to stop fretting over headlines, take some time out, and make sure you’ve got one for the next market panic.

SEE ALSO:

Is the oil market heading for a supply glut?

Oil prices are racing towards $100 a barrel. Brent crude futures hit $96 a barrel early this week, the highest level in more than seven years. That reflected fears of an imminent Russian invasion of Ukraine, a risk that traders had largely ignored until now. “Russia produces ten million barrels of oil a day, roughly 10% of global demand,” says Clifford Krauss in The New York Times. A war, and resulting Western sanctions, could remove some of that supply from global markets.

This week’s jump shows traders starting to “price in a sizeable geopolitical risk premium” into oil prices, say Christopher Matthews and Collin Eaton in The Wall Street Journal. While Western governments are reluctant to sanction Russian energy, they may ultimately be forced to do so.

Demand exceeds supply

Oil markets were already tight. The Opec+ group of producers, which includes Saudi Arabia and Russia, is struggling to keep up with demand: it has been raising production quotas in response to a recovering global economy, but several members are pumping less than they planned. Total output was a record 747,000 barrels per day short of the collective quota in December, according to energy-research firm BloombergNEF.

A slew of recent outages in Nigeria, Ecuador, Libya and Kazakhstan is keeping a lid on global supply, says Radmilla Suleymanova for Al Jazeera. At the same time, the Covid-19 Omicron variant has also failed to dent the world’s appetite for petroleum as much as had been feared at the end of last year. The International Energy Agency thinks that global demand for oil will return to pre-pandemic levels – roughly 100 million barrels per day – by the end of the year, up from the current level of 97 million per day, says The Economist. Some are more bullish: Opec+ expects demand to reach 103 million barrels per day.

Raising forecasts

Wall Street analysts have started to forecast $100 or even $120 a barrel oil, but not everyone is convinced. If Ukraine tensions cool and Washington manages to do a deal with Iran about its nuclear programme – which could bring one million barrels per day back onto global markets – then prices could yet fall. “The real wild card is shale,” says the Economist. US investors are thought to have lost $300bn in the last boom-and-bust cycle, but higher prices are tempting some oil prospectors to try their luck again. Not for the first time, American shale drillers may yet come to the rescue.

High oil prices are ultimately “self-correcting” because they encourage higher output, says Jeremy Warner in The Daily Telegraph, “but they can do an awful lot of damage in the meantime”. Oil appears to be following natural gas higher: European gas prices hit the oil-price equivalent of $350 a barrel late last year and are still trading at the oil-price equivalent of around $160 a barrel. That has given power stations in the US and Japan an incentive to shift from burning gas to burning oil for electricity, raising demand for the latter. Could oil spike as high as gas, towards $300 a barrel? “Perhaps not that high, but something much higher than now is certainly plausible.”

Oil prices have hit a seven-year high amid fresh tensions in the Middle East. Houthi rebels in Yemen claimed responsibility for a drone attack on an oil storage site in Abu Dhabi that killed three people on Monday. Brent crude topped $88 a barrel on Tuesday and has risen 13% so far this year.

“The attack is another reminder of the highly complex missile and drone threat faced by the UAE and the region’s other main oil producers,” says Torbjorn Soltvedt of risk intelligence firm Verisk Maplecroft. “Over the coming weeks, we expect oil’s Middle East risk premium to come more sharply into focus.” Analysts at Goldman Sachs are now predicting that Brent crude will hit $100 a barrel in the third quarter of this year, says Matt Egan for CNN.

The bank forecasts that “oil inventories in advanced economies will sink to their lowest level since 2000” this summer. Previous price spikes have subsided after US shale producers ramped up production. However, while US shale reserves are “large and elastic”, reduced investor willingness to fund fossil fuels means it could take higher prices to bring shale supplies into play this time.

The US is pressing Saudi Arabia and its allies in the Opec+ cartel, which accounts for around half of global oil output, to raise production, says Stanley Reed in The New York Times. The group slashed output by ten million barrels a day at the beginning of the pandemic and is only slowly restoring production.

Libya, Angola and Nigeria are undershooting their output targets because of “political turmoil, outmoded regulatory regimes” and creaking infrastructure. Saudi Arabia, which accounts for about 10% of the global market, could produce more, but Riyadh is so far ignoring Washington’s pleas for help for fear of “busting up the arrangement with other producers”.

The Omicron scare has rattled markets badly this week.

Unsurprisingly, the oil market has taken the hardest hit. If global travel becomes harder – and it is, with various governments reintroducing tougher restrictions after a brief period of loosening – then of course that’s going to hit oil demand.

But what about the longer run? After all, that’s what most of us as investors should care about.

Well, the longer run still looks rather more conducive to higher oil prices.

The oil price has crashed in two weeks

It’s been a tough few weeks for oil. First we had US president Joe Biden co-ordinating a release of oil from America’s strategic reserve with other partners around the globe. The idea behind this was to provide some relief at the petrol pump in the short-term and prop up his ratings.

It might well do this – no one likes higher petrol prices, they are the most visible indicator of consumer price inflation and the one most likely to contribute to social unrest. So staying on top of it is always a priority for most governments around the world.

But of course, breaking into your emergency stash today simply means you’ll need more oil tomorrow to stock it back up.

Secondly, we had the Omicron news. That really battered oil alongside the leisure sector and travel industry. As Dominic suggested yesterday, it increasingly looks like this is a squall for wider markets rather than “the big one”.

It’s also true that there are general mutterings among early reports that Omicron might be virulent but milder, and therefore potentially even helpful in terms of spreading immunity more widely. That’s a thesis which some JP Morgan analysts are suggesting could actually accelerate the end of the pandemic and be good news for re-opening.

However, none of that is clear quite yet, and, what with the Federal Reserve talking a more hawkish game recently too, fears that the recovery could suddenly grind to a halt have definitely grown, and that’s been bad for oil.

In all, these two factors contributed to oil sliding from above $80 a barrel just a couple of weeks ago to below $70 at one point yesterday.

Finally, oil cartel Opec+ hasn’t followed through on threats to adjust its own production to account for the strategic reserves releases. In its latest meeting, held yesterday, it went ahead with plans to produce more barrels from January.

However, this hasn’t hammered the market, because in an unusual move, it also stated that it is keeping its options open to making immediate shifts before the next meeting in January if necessary (that’s a bit like the Fed saying it might change interest rates between meetings).

In fact, oil rebounded from its $67-ish low yesterday partly as a result of this bet-hedging by Opec+.

Why there’s life left in oil demand yet

So what’s interesting is that this week, despite the plunge, a few analysts have been making very bullish noises.

I’ve seen at least two forecasts for Brent to hit $150 a barrel – one from JP Morgan and another from Jefferies.

(Big blowout forecasts are often a reliable sign of a top in the oil market. But these ones aren’t quite punchy enough for me to put them in that category. The ante was upped to $200 in the last oil boom so I’m looking for someone to suggest $250 or $300 before we top out this time round.)

The thesis is extremely simple; Christopher Wood of investment bank Jefferies sums it up on CNBC: “The issue for me is not the oil price, the issue is the pandemic. The oil price is going to go higher in a fully reopened world because nobody’s investing in oil but the world still consumes fossil fuels.”

I don’t actually have a great deal to add to that, but for some colour, let’s turn to JPMorgan which reckons that “capacity shocks” could see oil hit $125 a barrel next year, and $150 in 2023.

What’s interesting is that JPMorgan actually thinks that a chunk of this problem is about underinvestment on the behalf of Opec producers. The analysts reckon Opec’s spare capacity is a lot tighter than the consensus believes.

I’m sure that one day we won’t need oil. But I’m also quite confident that we’re also (sadly) quite a few years away from self-driven electric cars dominating our motorways. As Wood also pointed out, 84% of global energy demand was met by fossil fuels last year.

Something needs to plug the gap; that something is oil. And I suspect that we’ll find that our margin of safety is a lot slimmer than is currently believed – particularly if Omicron marks the end of the pandemic, rather than the start of a new wave.

This is something we’ll be discussing a lot more in upcoming issues of MoneyWeek magazine. Subscribe now if you haven’t already.

Not so very long ago, it looked as though demand for oil might have peaked.

The price of Brent crude, the European benchmark, fell below $20 a barrel and the price of West Texas Intermediate, the US benchmark, briefly turned negative.

This of course was down to the pandemic. But some assumed that we might also be getting our first glimpse of a brave new future without fossil fuels.

Instead,some think we could be looking at $100 a barrel before the year ends...

Why has demand for oil risen so much?

The price of Brent crude oil is hovering at around three-year highs, and almost touched $87 a barrel earlier this week, while US crude has risen above $85 a barrel. Both benchmarks have risen by around 20% since the start of September.

As Roger Diwan, oil analyst at consultancy IHS Markit, points out in the Financial Times: “The market is gripped by fears – fear of stronger demand, fear of a rally contagion from gas and power, fear of missing out on the rally, and the fear to rule them all: supply anxiety.”

The global energy crunch has followed the resumption of economic activity, as mass vaccinations led to an easing of Covid-19 restrictions. On top of this, a shortage of both gas (which you can read about here) and of coal, particularly in countries such as India and China, has prompted a switch to using oil for power generation in certain areas.

Coal shortages have left many states in India facing electricity blackouts, while in China, power cuts have left millions of homes without electricity. Even before the outages, China was looking to reduce coal pollution ahead of February, when it will host the Winter Olympics. As a result, many factories are switching to diesel as a substitute, driving up prices.

It’s not just a rise in demand – supply is being squeezed, too. Earlier this month, the Organisation of Petroleum Exporting Countries and its allies (known as “Opec+”) opted against further increasing supply – it had already cut production by 9.7 million barrels of oil per day in response to the drop in demand caused by Covid-19 last year, and it said it would stick to its original plan of adding just 400,000 barrels per day in November. Some had hoped it would bow to pressure from India and the US and raise supply even more.

What does oil’s price rise tell us about oil demand peaking?

So what of the longer-term hopes of the energy transition, when we all drive electric cars powered by solar and wind, and oil is a thing of the past?

There is little agreement on when the demand for oil will peak. BP says it may already have peaked in 2019 – although in another scenario it says the peak may take place in 2035. Norwegian oil and gas producer Equinor sees the peak happening between 2027 and 2028.

But what the oil price is telling us is that whatever the forecasts say, the world needs oil right now. We’d all like to live in a world where the energy is provided entirely by renewables, but getting there will take time. Wind power is all well and good until the wind stops blowing, which is exactly what happened in the UK this year – lower wind power output has contributed to the surge in natural gas prices.

It is clear that at some point the world will no longer want oil, but until then it is hard to see how oil producers won’t enjoy a prolonged period of higher returns – so they may have extra cash to hand out to shareholders. So which stocks should you consider taking a look at?

One of the easiest ways to play the market for UK investors is to invest in the iShares Oil & Gas Exploration & Production UCITS ETF (LSE: SPOG). This ETF has shot up by almost 50% from its August lows.

In the US, the Motley Fool suggests investors look at ConocoPhillips (NYSE: COP) as it benefits from “scale and access to some of the lowest-cost oil on earth”. Another option is ExxonMobil (NYSE: XOM) which operates in every segment of the oil and gas industry. While the past decade has seen some lacklustre returns, the Motley Fool says the company's recent strategy to focus on its highest return assets and its ”more recent efforts to reduce its business costs and boost efficiency are beginning to pay off”.

We also took a look at oil services companies in a recent issue of MoneyWeek magazine, where deep value investor Andrew Hunt took us on a tour of the sector and pulled out some promising-looking prospects. If you haven’t already subscribed, you can get your first six issue – plus a copy of The Sceptical Investor, John’s book – absolutely free if you join now.

Oil (as measured by WTI, the US benchmark) hit a seven-year high yesterday.

Brent crude oil (the European benchmark) meanwhile shot above $82 a barrel for the first time in three years.

Why the surge? And what does it mean for investors?

Opec is too disciplined for the market’s liking...

Oil cartel Opec-plus (that is, the usual Opec lot plus Russia) had a big meeting yesterday.

The oil price has been going up fairly strongly in the last year or so, but it’s been overshadowed somewhat by so many other commodities that it hasn’t really been drawing as much attention as it normally would.

However, now that we’re knee-deep in an energy crisis, when winter in the northern hemisphere hasn’t even begun, people are starting to pay attention.

Anyway, the oil cartel has been pretty disciplined in the post-Covid era. All the countries involved have been stung by collapsing oil prices and they’ve all been very wary of triggering another collapse.

Yet with prices rising at a solid clip and most of these nations quite keen to make more money, analysts and markets generally had expected yesterday’s meeting to end with a plan to increase crude production more significantly than they had already proposed.

But that’s not what we got. Instead, Opec said that it’ll stick to the current plan. That is, to only increase production by 400,000 barrels a day each month. That’s quite a gradual increase given that the global economy is opening back up again (in fits and starts).

Opec’s timing is really quite clever as well. The UN climate change talks are in Glasgow next month. For the next couple of months, politicians in developed markets are going to be competing with each other on who can pump out the greenest rhetoric. That’s going to make it quite tricky to publicly chide Opec for being stingy with what is, after all, a horrible dirty fuel of the past that we should all be glad to see the back of.

...and so are the US shale drillers

So what happens next? One assumption in the new era was that oil prices would be capped by US fracking. However, the problem there is that frackers have belatedly discovered price discipline.

There are some who have political interests in painting this as a “Joe Biden” issue. I have no idea how true that is – it might well be – but having seen how poorly Americans understand Brexit, I’m not going to bet that my Brit-centric grasp of US politics is any better.

And it doesn’t matter anyway. Scott Sheffield of Pioneer Natural Resources (the biggest shale operator) argues that “everybody’s going to be disciplined, regardless of whether it’s $75 Brent, $80 Brent, or $100 Brent… I don’t think the world can rely much on US shale. It’s really under Opec control.”

Shale companies are also having difficulty recruiting – particularly on the driver front (the shortage of truck drivers is global, despite what you may have read elsewhere). With operating costs rising they’re going to be even more wary about splashing the cash around.

Of course, Sheffield has an interest in talking things up and, whatever he says, there’s an oil price at which that “discipline” would break. But I don’t think we’re there yet.

So I can see oil prices continuing higher, particularly as the pressure increases on supplies of every other fossil fuel.

We’ve been suggesting you own oil majors since around March last year, and I see no reason to change that view now.

In the long run, are we going to move away from oil? Yes, of course. I hope so. If we don’t, it would suggest that humanity’s ability to innovate our way out of trouble really has reached some sort of peak.

However, that’s not going to happen overnight and in the meantime, a combination of ESG-mania and an over-reaction to last year’s negative oil prices has left the sector looking relatively cheap. And there aren’t many things that look cheap these days (no, not even after a couple of down-days on the S&P 500).

We’ll be discussing the energy transition and the best way to play it at the MoneyWeek Wealth Summit on 25 November. That’s a conversation I’m really looking forward to, I must admit – I’m keen to hear what our panellists have to say about it all. Make sure you don’t miss it – get your tickets here.

Brent crude oil prices have broken through $80 a barrel for the first time in almost three years. Oil’s rally comes as soaring European gas and coal prices presage a winter energy crisis. In September 2020 “in Europe it cost €119… to buy enough gas to heat the average home for a year”, says The Economist. “Today that figure is €738.”

A cold European spring and a hot Asian summer, combined with a post-pandemic industrial rebound, have kept demand high. Imports of US liquefied natural gas (LNG) on ships will help ease the pressure a little, but global gas markets depend mainly on pipelines and are only “imperfectly linked”.

Denting the global recovery

“Gas storage tanks in Europe are only 72% full ahead of the winter season, compared with the usual 87% at this time of the year”, Warren Patterson of ING tells Pierre Briançon in Barron’s. The global recovery, which was already “weakened by the Delta coronavirus variant, will take another hit”.

The crisis may yet ebb, says Kieran Clancy of Capital Economics. A mild winter in the northern hemisphere and the long-delayed approval of Russia’s Nord Stream 2 pipeline to Germany could restore balance to the market. That said, even then prices are still likely to remain elevated until at least spring next year.

“Hope is not a policy”, says John Kemp for Reuters. Governments are stepping in. Italy plans to spend €3bn on cushioning the blow to consumers. The trouble is that protecting householders from rising prices will only mean a bigger hit to industrial users, which could “disrupt supply chains and create shortages elsewhere in the economy… There is a limited global supply of gas [and it] must be rationed”. In Britain and elsewhere “residential and commercial customers” could do their bit by “turning down their heating this winter”.

Extra demand for oil

High natural-gas prices are having knock-on effects in other energy markets, says Julian Lee on Bloomberg. In Europe and Asia it is now “cheaper to burn oil than gas to generate electricity”. Oil trader Vitol Group predicts that such “fuel switching” will produce an extra “half a million barrels a day” in global oil demand this winter. The reopening of US borders to EU and British visitors also heralds a recovery in the long-haul aviation market, providing another tailwind for oil. Oil has staged a “remarkable recovery” since US prices went negative in April last year, says Matt Egan for CNN. Goldman Sachs, which has long been bullish on the fuel, now forecasts Brent crude will “hit $90 a barrel by the end of the year”.

Europe’s energy woes are spreading worldwide, says Stephen Stapczynski on Bloomberg. Even an average northern-hemisphere winter is likely to bring further price hikes. Soaring LNG prices will mean higher prices for Chinese-made steel and aluminium. “Economies that can’t afford the fuel – such as Pakistan or Bangladesh –could simply grind to a halt”. Long focused on oil prices, traders are “likely to learn how much the global economy depends on natural gas” this winter.

Yesterday, oil prices (as measured by Brent crude) raced past $80 barrel for the first time in three years. It’s the latest commodity of many to surge in value. West Texas Intermediate – WTI, the US benchmark – also hit a two-month high, at just above $76 a barrel.

So what’s going on and what do oil’s gains mean for you?

Why are oil prices rising?

As Reed Blakemore, deputy director of the Atlantic Council’s Global Energy Centre, tells Al Jazeera, the current “drama” in the market is due to a “collision of three massive forces: the impact of prolonged demand uncertainty due to Covid-19 on supply-side management over the past year; the structural changes of a policy-driven transition to a net-zero world; and the reality that sufficient investment and development of oil and gas supplies is still crucial to market stability even amidst a global energy transition”.

In other words, producers have struggled to match supply and demand in the short term due to lockdowns; while in the longer run, politicians are trying to swap us all to non-fossil fuels without really considering that we might need the old, mucky ones for a bit longer.

Most obviously, oil demand has rebounded sharply after its total collapse last year. In April 2020, Brent fell as low around $20 a barrel (hardly surprising when the whole world was locked up), while WTI (on some contracts) even turned negative briefly.

But positive news on vaccines and recovering higher economic activity following the easing of restrictions has seen the oil market to roar back to life. Brent is now up around 70% since the start of the year alone, while WTI is up more than 50%.

Another short-term factor is that the oil market is still reeling from the impact of Hurricane Ida which badly affected US supply last month. The fact that natural gas has gone through the roof is also having something of a knock-on effect to oil.

On top of all that, China specifically is enduring an energy shortage which is helping to underpin oil prices as it looks to cut down on pollution from coal in particular ahead of February, when it is due to host the Winter Olympics. As a result, many factories are switching to using diesel as an energy substitute.

Will oil prices remain this high?

In terms of supply, oil cartel Opec (plus Russia – known as Opec+) has just increased production. But oil prices have so far shrugged this off simply because it only matched increased demand – and as Goldman Sachs analysts point out, the impact of Hurricane Ida, which shuttered production capacity, offset the rise in oil production.

That’s likely to continue, even if supply is boosted further, reckons Barclays. "Opec+ tapering would not plug the oil supply gap through at least Q1 2022 as demand recovery is likely to continue to outpace this, due partly to limited capacity of some producers in the group to ramp up output".

Goldman Sachs now expects oil prices to level out around $90 a barrel by the end of the year, up from a previous estimate of $80. "While we have long held a bullish oil view, the current global supply-demand deficit is larger than we expected, with the recovery in global demand from the Delta impact even faster than our above-consensus forecast and with global supply remaining short of our below consensus forecasts'.

Of course, investment banks are constantly making forecasts about the oil price, and these are often wrong – notably, eye-catching calls that predict a price well in advance of current prices have tended to signal tops in the past. But a forecast for $90 isn’t so exuberant as to fit into that category. And even if prices don’t rise much further, there is no obvious reason to expect oil to crash either.

What does it mean for markets and the economy?

Higher oil spells higher petrol prices for consumers. And oil is of course a huge cost for companies too. So this could both spur inflation (which is already at a nine-year high) and hit disposable incomes (unless wages rise faster than prices – in which case corporate margins may well take a hit). In other words, this adds to the stagflation risks.

As far as investing goes, the winners are pretty obvious. Oil and gas companies should do well if prices stay high. One way to play this is via the iShares Oil & Gas Exploration & Production UCITS ETF (LSE: SPOG). which has risen sharply from its pandemic low, but is still trading below its pre-pandemic levels.

Today we consider oil.

Where’s it going next – up or down? That’s the question we all want to know the answer to, or at least I do, and so that is the question I shall be asking myself today.

Let’s start with some background – and we shall use Brent as our benchmark.

By the way, a little bit of insider info for you: whenever I write about crude oil, the number of hits my article gets plummets. This has been the case for years. House prices, bitcoin, gold – readers can’t get enough of them. But oil? Few seem to care.

Perhaps that in itself is a bullish contrarian indicator. I have found it a reliable investment strategy over the years, especially with commodities, to find markets that nobody cares about. Boring markets. It means the hype is still to come.

My trade of the lustrum has delivered nicely

I come to this article with a slightly blinkered view. Generally speaking, I am an oil bull. In early 2016, when it slipped below $30, I declared oil “my trade of the lustrum”. A lustrum, for readers unfamiliar with the word, is a five-year period, so that trade is now maturing.

Our chosen vehicle was not BP or Shell, the first companies that spring to mind as ways to play the oil price. For some reason, unknown to me, both are useless as proxies, so we declared avoid and we are both pleased with and justified by that declaration.

The oil price has more than doubled, and BP and Shell are both down. “Never sell Shell” is the motto. Never buy it, is my advice.

No, our chosen vehicle was BHP Billiton (LSE: BHP) at 700p. Despite being known as a mining giant, oil is in fact its single largest product, and, unlike the ETFs, it acts as a much better proxy. It tracks the oil price and gives you a bit of fizz on top. Brent has roughly doubled since our lustrum declaration, going from $36 to $75. BHP has more than tripled.

We recommended it at 700p and now it is 2,316p.

The noughties was the oil decade. In 1999 oil went below $10/barrel. In early 2008 it was $147.50. A fifteen bagger, no less.

The 2010s began well with Brent trading constantly above $100. Then in mid-2014 two years of horrible bear market saw it drop from $115-odd to $27 by early 2016. That was when we started sniffing around.

It hasn’t been an easy lustrum, well though it began. In late 2018, three years after our declaration, oil was flirting with $87 and we looked mightily clever, as we sat stroking a white cat and telling anyone who would listen how clever we were. By 2020 the oil price has gone negative – negative! – and to this day we remain unsure what happened to the cat.

But we held. We HODLd for dear life like the most committed of bitcoin zealots, and the market rewarded us.

Oil wants to sell off right now, but demand will only increase

Now we are feeling a bit jumpy again. Oil looks like it wants to sell off. In fact, last week it did sell off – it lost ten bucks in barely the blink of an eye. But now it’s bounced back again with impressive vim. Then again, it does now seem to be in something of an intermediate-term downtrend.

The spat between Saudi Arabia and the UAE over oil production quotas seems to have abated, and now the Opec nations together with Russia have agreed to increase their output with the aim of reducing prices and easing pressure on the world economy. The supply boost starts in August.

Please don’t ask me to explain Opec or how that line of thinking works. Surely if you are selling something you want to get the most you can for it, not the least? If you are an oil producer you want a bull market. Especially if oil supplies really are running down – the pressure to get the biggest return intensifies. Surely? They’re not producing oil for the fun of it, or for charity.

It’s always baffled me, and no doubt there is some kind of geo-political shadiness behind the scenes that explains it all, but in the meantime I shake my head and carry on.

BHP, meanwhile, has “gone up a lot”, which shows you the kind of logic I get reduced to sometimes, and often when something “goes up a lot” that means it has to at least pause. Doesn’t it? (No, is the answer).

With some broad brush strokes, oil demand, green energy revolution or not, is set to increase. The Covid setback will look like a blip on a long-term chart of oil demand – falling by around 10% before bouncing straight back – and demand now looks set to hit 100 million barrels per day next year.

I keep banging the drum on this: the Green Energy Revolution is going to increase oil demand. Meanwhile social pressure and government pressure, through taxes and laws, will mean reduced expenditure on exploration and development. The result will be higher prices.

So my outlook is that we consolidate over the next few months, we back and fill. We might even go back and have another look at $50. But in the longer-term, oil goes higher – much higher – and oil at $100 in 2022 is not such a remote possibility.

In March last year, oil cartel Opec+ “held a disastrous meeting in which it failed miserably to reach an agreement”, says John Authers on Bloomberg. Oil prices subsequently plunged. This month “Opec+ has held another disastrous meeting in which it failed miserably to reach an agreement”.

The result? Prices have risen. Brent crude oil prices have soared above $77 a barrel, the highest level since October 2018. US oil benchmark WTI briefly hit $76.98 a barrel, a seven-year high.

Saudi Arabia and the UAE fall out

The Opec+ cartel brings together major oil producers such as Saudi Arabia, Russia, Iraq and the United Arab Emirates (UAE). The group controls 50% of global oil output, and tries to keep prices stable. Opec+ found itself “staring into the abyss” last year, says Tom Holland of Gavekal Research.

A Saudi-Russian price war, combined with Covid-19 lockdowns, saw prices plunge. US futures briefly went below zero. To rescue the market, Opec+ members agreed to cut their joint output by ten million barrels per day (mbpd) compared with pre-pandemic levels (equivalent to roughly 10% of global production).

The group has since eased those curbs, but it is still pumping six mbpd less than it did pre-pandemic. The group had been expected to agree to further output hikes in the months ahead, but talks failed. Markets are betting that supply will thus remain tight and that prices could head towards $100 a barrel.

The quarrel came from an unexpected source. The UAE, traditionally a close ally of Saudi Arabia, has been resisting Saudi plans to keep some production curbs in place through to the end of next year. The UAE says it is only willing to agree if its own production quota can be raised. We have “sacrificed the most, making one-third of our production idle for two years”, energy minister Suhail Al Mazrouei told CNBC.

There is more to the dispute than money, says Al Jazeera. Riyadh and Abu Dhabi are at odds over foreign policy. Saudi economic pressure on Emirati free zones, “areas in which foreign companies can operate under light regulation”, is another bone of contention.

Opec is “sitting pretty”

Traders are getting carried away, says Holland. The two Gulf allies may “patch up their disagreement” before too long. With prices surging, other Opec members will also be more tempted to cheat on their agreements and pump extra oil on the sly.

Opec’s “purpose is to get as much money as it can for its oil”, adds Authers. Disharmony in the group should really mean cheaper oil. A more quarrelsome Opec means oil markets may be more volatile, but “it would be risky to bet… that this meeting” heralds much higher oil prices.

Don’t bet on a price plunge either though, says George Hay on Breakingviews. The market is likely to remain in deficit until the end of 2022 thanks to “surging crude consumption”. High prices are also not tempting US shale producers into the market as before: “Climate change and profitability concerns are deterring listed oil groups from ramping up output.” For all the “squabbling”, Opec is “sitting pretty”.

Oil prices jumped to a seven year high on Tuesday after the Organisation of the Petroleum Exporting Countries (Opec) and non-Opec members delayed a crucial meeting which was meant to determine the future of oil prices in the months ahead.

The price of Brent crude oil jumped to $77.84 on Tuesday morning; the last time it was this high was the end of 2018. Meanwhile US oil prices – West Texas Intermediate – traded at seven-year highs.

Both benchmarks later gave up their gains.

So what’s going on? Here is a broad summary of the story so far.

Why is the Opec+ meeting delayed?

The Opec+ meeting scheduled to take place on Monday was delayed after the United Arab Emirates opposed a suggestion to extend production curbs for an additional eight months.

“The 18th Opec and non-Opec ministerial meeting has been called off”, Mohammad Sanusi Barkindo, Opec’s secretary general said in a statement.

As Tom Holland of Gavekal Research says, “members are bickering over how their baselines should be set in future”.

In other words, countries such as the United Arab Emirates argue that baseline production figures – measures used by countries to calculate how much their production should be cut by – must be raised to factor in higher output capabilities, according to the Financial Times.

What are the key sticking points?

UAE stresses its output of 3.2 million barrels per day, in place since April 2020, is too low. It believes the figure should be revised to 3.8 million barrels per day. Other countries insist this is unfair.

Opec+countries were pushing to increase production from 400,000 barrels per day from August to December.

“After days of tense discussions and plenty of infighting between Saudi Arabia and the United Arab Emirates, the group failed to agree to ease output curbs, instead abandoning the meeting,” says Sophie Griffiths, market analyst at OANDA.

Other than production baselines, there are also talks of extending last year’s historic agreement made by Opec and its allies for the whole of 2022 – which the UAE opposes.

The groups, which include some of the world’s richest oil producers, have not set a fresh date to resume talks. This is significant because it means the oil market faces much uncertainty on its future direction just as the market recovers from the Covid pandemic.

What agreement was in place throughout the pandemic?

This raises the question, how did oil markets fare during the pandemic, and what measures were put in place to protect the market from collapse?

Like several other asset classes, oil has seen plenty of volatility and wild price moves over the past several months. Brent crashed from around $65 a barrel last February to just above $22 a barrel last April, meanwhile West Texas Intermediate – the US benchmark– briefly turned negative.

This came despite Opec and its allies reaching a historic output deal last April which led to a production cut of 9.7 million barrels per day.

Oil prices turned jittery last year when Saudi Arabia and Russia engaged in a brutal price war even before the pandemic wreaked havoc in financial markets.

After the Opec+ agreement, most countries maintained a highly unusual level of compliance with the quotas throughout the pandemic, and some countries even cut production more than they needed to. Oil prices then staged a dramatic recovery; more so in recent months when economic activity began to resume across the world.

Opec’s current quotas are roughly six million barrels per day below baseline and the market reached a situation where demand has exceeded the production of oil causing a tight market.

“Today, the cartel’s members all agree that they should increase their quotas further, adding at least an additional two million barrels per day by the end of the year, bringing their output to a little less than four million barrels per day below baseline, and plugging much of the current supply deficit,” says Holland.

But the standoff between the UAE and Saudi Arabia shows this is far from simple.

What does the impasse mean for investors?

Much depends on whether an oil agreement is struck or not. The longer it takes to secure a deal, the more likely that prices will remain at multi-year highs.

After oil prices shot up on Tuesday, Brent had fallen back to below $75 by Wednesday morning, meaning markets look likely to expect an Opec agreement.

But failure to secure a deal could still support the market. While there have been concerns that the delta variant of the Covid-19 virus may dent demand for oil markets – especially given that India is the world’s third largest consumer of oil – it still appears that markets are very much focusing on reflation trade and the global economic recovery.

A bigger concern may be the eventual breakup of the Opec+ agreement; there is the possibility that “ Opec+ could fragment, with one or more major producers walking away in order to maximise production at the expense of remaining members”, Holland says.

Such a scenario could result in a very bearish market. As extreme as that scenario may seem, the standoff between Saudi Arabia and Russia last March shows such a possibility is far from unrealistic.

But more importantly for investors may be the price of Brent this year, as this may determine whether oil will cause inflationary pressures or not. Higher oil prices can increase costs to companies and generate inflation.

If Brent stalls at $80 this year, then its year-on-year increase will fall from 80% to 56%, and it will no longer be the culprit for higher headline inflation rates, Holland says.

“On the other hand, if Brent climbs to US$100 a barrel by the beginning of November, the year-on-year increase will more than double to 175%, contributing mightily to higher consumer inflation,” he adds.

Either way, the price of oil will keep all market watchers on their toes in coming months.

Like you I’m sure, I‘m quite a few kilos heavier than I like to be. I began 2020 at 83kg, feeling as though I should be two or three kilos lighter. Here we are, 18 months later, and I’m 89kg, afflicted with the same lockdown expansion that has got to so many of us.

If you’re wondering what my expanding waistline has to do with anything financial, then all I have to say is – read on.

The green crusade is in danger of backfiring badly

I put my unwelcome weight gain down to two things. First, the loss of incidental exercise – walking to the tube station in the morning, that kind of thing – and, second, to the fact that being at home, I never seem to miss a meal.

Before Covid, running around town on busy days, there would always be times when I’d skip meals, meaning I would effectively be intermittent fasting.

Amazon, no doubt knowing about my weight concerns (as it seems to know everything), suggested I read Why We Eat (Too Much): The New Science of Appetite. The author, Andrew Jenkinson, traces today’s obesity crisis to the changes in diets that came about in the early 1980s – increased sugar and, especially, trans-fat consumption. These changes came about as a result of flawed public health advice.

Governments based their new dietary advice on flimsy science, Jenkinson argues, under huge lobbying pressure from the food industry. Fast forward to today, and I can’t help thinking that something similar is happening with green energy. There are parallels galore.

Governments are under huge lobbying pressure to be “greener”. As a result, they are taking action – practically competing with each other in many cases – and we now have these extraordinary targets in place. Today’s latest is that halogen lightbulbs are to be banned from September.

I can’t help thinking it is all going to backfire badly. There’s the cost, which takes two forms. Firstly, financial. “The bill for decarbonising the economy is estimated to surpass £100,000 per household. Whitehall claims the number is lower but won’t let anyone see their calculations,” says Steve Baker, MP.

£100,000 per household – who can afford that? Then there’s the environmental cost. The amount of fossil fuel required to realise the green energy revolution, if only to mine the required metals in the timeframes given, means the revolution will be anything but green.

I don’t think anyone is pro-pollution, by the way. We all want to see a world with cleaner oceans, better air quality, more forests and so on. If cleaner, cheaper, more efficient energy sources than burning fossil fuels can be found, we will, all of us, embrace them.

Better, cleaner, more efficient energy consumption is inevitable. It’s part of progress. Humans have been getting better at consuming energy ever since we first stepped onto the fertile planes between the Tigris and the Euphrates, and probably before. So I do not doubt the good intention of those involved in this targeting. It is my trust in the competence of governments that is low.

Which brings me, belatedly, to the investment point of today’s Money Morning. I think the oil price is going higher. A lot higher.

Oil is only heading higher from here

At $70 a barrel, WTI crude is now up by more than $100 from the “minus $37” lows it hit in the Covid panic last year. It’s in an uptrend and, as Charlie Morris notes in his latest Fleet Street Letter, is trading above its five-year averages.

Oil demand is not going away. Green energy revolution or not, “aviation, shipping and petrochemicals will continue to rely on oil for some time”, says Morris.

Oil demand is creeping back towards its long-term trend. Pre-Covid, global oil demand stood at 99 million barrels a day. It fell to 91 million with the Covid shock. The IEA says it will pass 100 million in 2023. Global money printing is also likely to push prices higher. In fact, the oil price is probably a better measure of inflation than government measures such as CPI.

In the meantime, the oil industry is being attacked. “US President Joe Biden has suspended oil drilling leases in Alaska,” notes Morris. “A Dutch court has ordered Royal Dutch Shell to cut 45% of its 2019 greenhouse gas emissions by 2030.” It’s hardly incentivising people to invest in exploration.

Who’d work in the oil industry? It’s a difficult and dangerous business; the hard work and risks, the far corners of the earth you have to go to, require compensation. It’s much easier to go and design an app. You know what happens when supply can’t meet demand.

Charlie Morris again: “The energy market is a complex space that has been developed over decades. To interfere with it, on such a large scale and in such a short period of time, is madness. Perhaps governments and inter-governmental agencies such as the IEA know that.

“However, most of the individuals who are involved will be long out of the public eye by the time that the flawed plan is exposed as a failure. To implement ‘net zero’ by 2050 means we will return to mass poverty. It will not happen.”

We are not here to judge, only to seek out investment trends. So we sigh and we shake our heads, but we see oil quite comfortably heading past $100 next year. It might even make it to $150. Remember the crisis last time oil went to $150?

Daylight Robbery – How Tax Shaped The Past And Will Change The Future is now out in paperback at Amazon and all good bookstores with the audiobook, read by Dominic, on Audible and elsewhere.

I find markets endlessly fascinating. One minute, an asset is dead in the dirt. No one wants it. If you hold it, you’re a fool. It’s practically radioactive. The price might be low, but it’s not cheap. It’s yesterday’s asset.

Next minute, it’s shot up and suddenly everyone wants a piece of it. The price might be high, but it’s only going higher. I’m not talking about bitcoin (though the story applies equally). I’m talking about oil.

Extrapolation can be a handy source of contrarian investment ideas

I’ve told this story a lot in recent months so I won’t belabour it today. But oil has been on a serious tear in recent weeks.

At the start of November – so just over three months ago – you could buy a barrel of Brent crude for less than $40 (for simplicity’s sake, let’s not worry about how you’d store it). This morning, it’ll cost you more than $60. That’s a 50% increase in just a few months. I mean, sure, it’s no GameStop. But it’s pretty good going for a boring old fossil fuel that had been written off as yesterday’s old dinosaur gunk.

Oil companies have been queueing up to disavow the stuff. Investors have been competing with one another to see who can condemn stranded assets and laud the rise of electrification the loudest. And the Covid-19 lockdowns have created a false sense of collapsing demand and accelerated transition. This last point is hard to wrap your brain around, but it’s absolutely vital to understand if you want to be an active investor (ie, you want to try to beat the market by taking advantage of temporary mis-valuation opportunities created by people’s behavioural tics or other non-fundamental factors).

No rational person would believe that the current drop in oil demand is because we all now drive Teslas. Everyone understands – in their head – that this is because the global economy has been shut down by a virus. Everyone understands – in their heads – that planes will one day fly again, and that it will take a bit longer before the economy is fully weaned off fossil fuels. However, as human beings, we’re terribly prone to an immediacy bias. We can’t help but extrapolate our present situation way out into the future.

I mean, think about it: how well do you remember life before the pandemic? We’ve been doing this for a year now. I watched Die Hard with my kids at Christmas (it’s a Christmas film, after all). There’s a scene near the start where Bruce Willis gets off a plane and goes into the airport. One of us said: “Wow – it looks weird to see no one wearing masks!” It’s not that we won’t go back to normal – I can’t wait. But it’s just hard to remember, when you’re in the thick of it, what it’s like to be in a different situation. And the same bias goes for investors.

Of course now, as people wake up to the idea that oil is rising in price again, the story is starting to shift again. This is “reflexivity” in action. George Soros writes well about it, but it’s not really complicated. It just means that investor perceptions affect markets, but markets affect investor perceptions, so it’s all a big feedback loop.

Oil prices might be due a breather – but that’s all it will be

Anyway, so now we’re hearing bigger calls and talk of a commodities supercycle. Apparently, on a conference call last week, JPMorgan’s head of oil and gas told the investment bank’s clients that “we could see oil overshoot towards, or even above, $100 a barrel”, reports the FT’s energy editor.

To be clear, when you start hearing analysts make calls like this, it usually means the market is due a breather. Again, it’s all down to psychology: the analyst works in the sector; the sector has been boring and neglected for a while – that’s not a nice place to be. Then suddenly – with no real warning – you’re in the hot seat again. Suddenly your little patch of the market is the hottest thing in the market, rivalling the likes of bitcoin and meme stocks for popularity. You get excited – more excited than everyone else in the room. You make a big round-number call... and that marks the point at which it all calms down a bit again.

However. I’d emphasise that we’re just talking about a breather here. When an asset moves this far and this fast you’d expect a bit of exuberance followed by a catch-up pause. But overall, oil is not especially expensive (you only have to go back to 2018 for prices above $80).

Moreover, we have plenty of supporting factors behind the oil price surge. Firstly, the Biden administration in the US has been rather less accommodating of Iran in terms of sanctions than some had expected. Secondly, the stimulus measures are now in focus given that all the theatre of the Trump impeachment is over. Throw in that $1.9trn on top of an economy that’s already going to be one of the most rapidly vaccinated (the Americans are a bit like us – not great at the containment side but doing a good job of the vaccination bit), and you have a recipe for a very strong rebound.

In short, hang on to your oil plays. Dominic reckons BHP is the best single-stock bet – yes, I know it’s a miner but he laid out the rationale here.

And for more on inflation, stimulus, investment, oil prices, and plenty more, make sure to subscribe to MoneyWeek – get your first six issues free here.

Oil prices have returned to pre-pandemic levels. The price of the world’s favourite commodity slumped last spring as major economies locked down. US oil futures briefly turned negative as traders found themselves stuck with fuel that nobody wanted. Yet Brent crude prices have rocketed by 180% since their nadir to trade above $60 a barrel this week. Before Covid-19 took hold the contract was trading around $59 a barrel.

Joe Biden’s announcement that he will not lift sanctions on Iran (see page 10) provided the “immediate catalyst” for the latest price bump, says Julia Horowitz on CNN. But the broader rally is all about the vaccines and hopes that big economies are well on the way to returning to normal. On the supply side, oil exporters’ cartel Opec and ally Russia have continued to limit output. Saudi Arabia’s announcement that it will cut output by a further one million barrels per day (mbpd) from this month has provided an extra fillip. Opec and its allies have “held back a cumulative 2.1 billion barrels of oil” since last April, says Justin Harper for the BBC. They didn’t have much choice: air passenger traffic is still down by 70% on last year.

US producers have done their bit too, says Joe Wallace in The Wall Street Journal. The country is “pumping 17% less crude” than it was on the eve of the pandemic as lower prices have forced the closure of less economical wells and halted new exploration.

The medium-term outlook for oil is positive, but expect setbacks along the way. This rally is “overextended”, says David Sheppard in the Financial Times. Prices may be back at pre-pandemic levels, but demand, still six mbpd below 2019 levels, is not. There is “excessive... bullish exuberance” in oil markets, says Stephen Brennock of brokerage PVM. Traders are high on the promise of stimulus.

We've spent the first week of the New Year with much of the world entering new lockdowns. For many, the excitement at leaving the dreaded 2020 behind has been replaced with a realisation that 2021 is simply 2020, but older.

Anyway, with that relentlessly cheery thought in mind, here's a puzzle for Friday: if lockdowns are going on for longer than expected, why is the oil price higher?

Coronavirus is still wreaking havoc and sparking new lockdowns across the globe. That's unlikely to be great news for air traffic in the near term. And yet the oil price has risen strongly in the last week. Brent crude kicked off the New Year trading at around $51 a barrel. This morning, it's well above $54 a barrel.

The surprising generosity of Saudi Arabia

It's partly down to the continued enthusiasm for assets generally. Investors who missed out on rebound gains last year feel that they need to make up for it by buying laggards in the hope that they'll catch up with all the popular assets.

But there's a more specific reason behind oil's gain. Earlier this week, the “Opec+” oil cartel – consisting of the Gulf states led by Saudi Arabia, and Russia – got together, and decided to restrict supply by more than markets had expected. Russia still plans to raise production (co-operative as ever), but Saudi Arabia pledged to cut another million barrels of production to compensate, while most of the other countries in the cartel said they would hold production steady.

Presumably, oil producers are worried that the new spread of the virus will trigger a new slide in demand, and thus hit prices. That's one argument. That said, some analysts suggested that the generosity of the Saudi cut seemed “too good to be true”. After all, Saudi Arabia and Russia are rivals as much as allies. And that's before you consider the US shale oil producers.

On the other hand, you could argue that this is a simple “belt and braces” move. And the US election result probably helps. Under a Democrat-led US government, shale oil producers will struggle to expand as rapidly (if at all) as they would have under a Republican government. And that's before you consider the fact that the shale oil sector (like much of the wider commodities sector) is currently in consolidation mode – they need to start showing investors that they can be trusted with their money, rather than just splashing it wildly on every project that comes to hand. So the Saudis might just be making a short-term move to try to ensure that the oil price doesn't crash hard again. It's as much about sentiment as anything else.

The reason it's interesting is because the importance of oil prices is consistently underestimated. Oil price spikes are not helpful for the global economy. Oil is an input price into just about everything. So it acts as both a tax (it sucks up money that could otherwise be spent elsewhere) and an inflationary pressure (it drives up prices). There's even an argument to say that spiking oil prices actually triggered the 2008 financial crisis. (I think that's going too far, but they certainly contributed to the pressure).

Yet right now, oil is still largely dismissed as being on its way out. It's a dreadful fossil fuel that will be replaced by hydrogen or sunshine or wind or the power of positive thinking or something like that. Well, what if we're not quite there yet?

Could rising oil prices prick the US stockmarket bubble?

Charles Gave of Gavekal makes the interesting observation in a recent research note that “in the past, a major rise in the oil price has always been followed by a fall in the Shiller p/e ratio.” Now, for those who remain blissfully unaware, the Shiller price/earnings ratio, or Cape ratio, looks at the valuation of a market (or stock) based on an inflation-adjusted average of its earnings over the past ten years, rather than a single year (you can read more on it here).

The point is to smooth out earnings over the economic cycle. If you rely on one year's data, you might be getting the high point or the low point in earnings, and so get a skewed view of how cheap or expensive an asset really is. For example, mining stocks will tend to look very cheap on a p/e basis when their earnings are at peak levels (during a commodity boom), while they'll look very expensive when a commodity bust is underway (because earnings plunge).

The Cape is not much use for timing the market, but it does have a history of predicting future returns better than most other measures. (Note, that doesn't mean it's foolproof – it just means that if you're going to use a valuation measure, this one has a better track record than most.) If you buy when the Cape says a market is cheap, history indicates that your long-term returns will be better than if you buy when the Cape says a market is expensive.

The debate over the Cape has been more heated than usual recently, because the US stockmarket – the S&P 500 – has been expensive on a Cape basis for a long time. Now, all the caveats about Cape not being a timing tool are well known. But we're all human beings, and thus impatient. So when we think a market is overvalued, we want to see the thing fall there and then, not seven years later.

The conclusion – even by Robert Shiller himself – is that low interest rates are what's keeping market valuations high. That makes some sense. If your alternative to owning stocks is to own a bond in which you lose money after inflation, then that suggests you should be willing to pay a bit more for stocks than you would if the return on bonds was higher.

But what happens if oil prices perk up? And inflation perks up as a result? And interest rates grow harder to keep down? Jeremy Grantham, co-founder of GMO, just put out a note declaring that he thinks the US is in an epic bubble, on a par “with the South Sea bubble, 1929, and 2000”. Grantham tends to be early, but he also tends to be right.

To me the simple answer is to stick with assets that are undervalued and reduce your exposure to those that are very expensive. We look at the importance of rebalancing in the current issue of MoneyWeek out today. If you don't already subscribe, take the opportunity of a new year to get your finances in order, and get your first six issues free here.

Contrarian investors pride themselves in buying sectors and companies that everyone else hates.

That’s the idea, at least. But it’s a lot easier said than done, because when everyone hates a sector, there’s usually a very convincing reason for it.

And yet, there’s one particular sector in the market that seems to be gaining even more hate than is justified right now.

Why are oil prices so low?

In March this year, the share price of Royal Dutch Shell slid below £10 a pop. Back then, Shell was yet to cut its dividend, giving it a yield well into double-digit territory.

Now, Shell’s share price is back below £10. The absolute dividend payout is a lot smaller, having been cut by about two-thirds back in April – the first such cut since World War II. And yet it still yields around 6%.

That’s quite extraordinary. It’s the same story for BP. And for Exxon Mobil in the US.

There are plenty of individual stocks around whose share prices are near or even below their initial Covid-19 lows. That’s no surprise. The market is sorting the survivors from the stragglers and the latest lockdown wave is going to prove the death knell for at least some of the latter.

But we’re talking an entire sector here; the only sector that comes anywhere close in terms of universal investor loathing is the banking sector.

So what’s going on? There are two main issues here.

Right now we have a bit of a bull market in “green” tech and ESG investing (that is, investing with environmental, social and governance issues in mind). Everyone is talking about an electric vehicle led, low carbon future. So your old school fossil fuel stocks are out on their ears, and the hot young solar and hydrogen stocks are having a ball.

Does this make sense?

Are we going to move away from fossil fuels in the long run? It’s the goal. It appears to be achievable as long as we’re willing to throw enough money and time at it. So in the long run, I think the answer is probably “yes”. And I imagine most of us would welcome that.

Is it likely to happen as quickly as the market now thinks? That’s where I am more sceptical. You only need to look at the dotcom bubble to see how markets can get their timing wrong when they’re gripped by enthusiasm.

The internet did change the world, and it did completely upturn many industries in ways that only the most wide-eyed optimists foretold in the late 1990s. But even although the optimists were right, the valuations were still wrong.

There may be a future utopia in which we all drive (or are driven around by) hydrogen or lithium-fuelled cars, and all of our electricity comes from wind power (in the UK) or solar power (in nicer climes). Oh, and we don’t use any plastic and we live in peace with the turtles.

But between now and utopia, we still have to get from A to B and we still have to use plastic. So even if oil demand drops, it’s not going to vanish. And that’s assuming we even reach utopia – there’s a lot of global co-operation baked into that assumption and a glance around the world right now will tell you how realistic that is.

How ethical investing could drive oil prices higher

Anyway – while that’s all very interesting, it’s also a bit of a red herring. The scale of the present collapse has very little to do with the rise of ESG, or hopes that we’ll all be driving electric cars in future.

Oil prices collapsed in March and April for the same reason that everything else collapsed: everyone and everything stopped moving. You don’t need oil if you’re not driving and you’re not flying. It’s that simple.

On top of that, you had a price war between Saudi Arabia and Russia. That’s since been called off, but that’s what drove prices to their absolute nadir.

The question then is: what’s going to pull oil prices back up? Because that’s the only thing that will provide more hope for the share prices of the downtrodden oil majors.

There are two obvious answers. On the demand side, we need the global economy to open back up. That’s happening, albeit slowly. On the supply side, we need oil producers to produce less oil.

And this is where the “green” bubble side of things comes back in. It’s easy to be cynical about ESG, because many companies use it in a cynical manner. “Greenwashing” – talking up your environmental commitments purely for PR purposes – is rife.

But sometimes these behavioural shifts can have a real impact. JP Morgan is the biggest lender to US shale oil companies. The bank is now saying that it’s going to rein in its lending to fossil fuel producers.

Now, ESG might just be a good excuse to pull loans to companies that have never and will never make a profit. But whatever the reason, if shale producers have their credit lifelines yanked away from them, then US oil production can’t help but fall. And if that happens then supply could take a big hit.

Will it happen soon enough to drive oil prices higher? I don’t know. But what I do know is that the sector is deeply disliked, which suggests that the market is overly gloomy rather than overly upbeat. In turn, that means it’ll be easier for expectations to be beaten to the upside rather than the downside.

In short, I’d rather be long the oil companies than short them right now. And if you don’t fancy doing a lot of research into individual oil companies, something as simple as a FTSE 100 tracker or fund will get you a decent amount of exposure to oil as well as a lot of equally hated bank stocks.

We wrote about oil and the green future (and more specific ways to invest in both) in a recent issue of MoneyWeek magazine. If you’re not already a subscriber, get your first six issues free here.

Are we heading for another oil-price slump? Benchmark Brent crude futures plunged to an 18-year low of around $19 a barrel in April, while US oil futures briefly went negative. Prices have since climbed out of the lockdown hole, with Brent trading around $45 a barrel over the summer. Yet the rally has now stalled, with prices down by 6% since 1 September to about $42.50 a barrel.

Global demand for oil is wobbly. A second wave of Covid-19 will see more people working from home, while lapsing government support programmes make for a shakier outlook for consumption and global trade. Global crude oil demand was roughly 100 million barrels per day (mbpd) in 2019, but is likely to be closer to 90 mbpd this year, according to forecasts by oil-exporters’ cartel Opec. In Japan, the world’s fourth-biggest crude importer, imports fell by more than 25% on the year in August, says Bozorgmehr Sharafedin in Reuters.

Bulls are looking to the supply side. The price crash has battered US shale oil, says Myles McCormick in the Financial Times. Upstream energy firms with a combined $85bn of debt have filed for bankruptcy protection over the last eight months. Many investors are “fed up” with the unprofitable sector and won’t bankroll further losses. US oil output peaked at 13 mbpd at the start of this year, but is currently below 11 mbpd says the Energy Information Administration.

Oil-Price War Two?

Yet reduced output will only gradually make a dent in the world’s swollen stockpiles. Countries such as China used the April price crash as an opportunity to fill up the national tank at a bargain price. Global inventories remain above historic levels and “spare capacity” in the supply chain is “at the highest levels in 25 years”, says Steve Goldstein in Barron’s.

April’s oil-price crash was triggered by a Saudi-Russian “price war”. Unable to agree on how to manage slumping demand amid the first wave of lockdowns, the two sides resorted to flooding the market with crude in an all-out effort to win market share.

After the price war, however, Opec+, a grouping led by Saudi Arabia and Russia, got its act together, cutting collective output by 9.7 mbpd in April compared with 2018 output levels. That move stabilised the market. Those cuts are being reduced, but still stand at 7.7 mbpd. Could we be in for a repeat performance? Riyadh and Moscow are split over how to manage the latest demand hit, says Julian Lee on Bloomberg. Russia prefers to wait and see, but the Saudis have called for a more “proactive and preemptive” approach that favours new cuts to keep prices buoyant. This is all strikingly similar to what happened in March. Don’t rule out “another showdown before the end of the year”.

US futures plunged below zero in April due to Covid-19’s destruction of demand and a US-Saudi price war. Yet oil then staged an 88% rally during May.

Slowly reopening economies and the recent producers’ deal to cut output by ten million barrels per day in May and June – a deal that this week looked set to be extended – have stabilised the market. Brent crude continued its rally early this week, eclipsing $40 a barrel.

The recovery still leaves the industry and the countries that depend on it in a difficult spot, says Ed Clowes in The Daily Telegraph. Many US shale drillers need prices above $50 to survive. Distressed debt in North American energy tops $190bn. Saudi Arabia has been forced to bring in tough austerity measures to balance the books, slashing benefits and effectively tripling VAT. Lower prices saw Russian GDP contract by 28% in April. Closer to home, some analysts warn that the shakeout could “accelerate the death of the North Sea”, where fields are becoming uneconomical.

The pandemic has also eclipsed the oil market’s usual geopolitical worries, says Samuel Burman of Capital Economics. So great has the demand destruction been that even if Iran blocked the crucial Strait of Hormuz shipping route there would be little impact on prices; many Middle Eastern states are cutting back exports anyway.

The most bullish analysts think the supply glut could end in weeks, writes Ellen Wald for Barron’s. Yet economic reopening is just the first stage on the path to more normal demand for the word’s favourite commodity. Fear of the virus remains widespread, meaning many are still avoiding travel and leisure. The market must also contend with the scarring effects of a deep recession. The journey back to pre-crisis levels of oil demand will be a long one.

The oil market is continuing to blow a gasket. Yesterday, the US oil benchmark, West Texas Intermediate (WTI) for June delivery, fell hard again.

This time it was related to an oil exchange-traded fund (ETF) dumping a whole load of oil contracts so that it doesn’t end up getting caught out by the same negative oil price issues that arose a week ago.

We discussed all the technicalities behind that last week. What’s more interesting to me today is this – how did we end up with this massive glut in the first place? And what does it tell us about the wider economy?

The real reason the world is swimming in oil

Oil is fascinating. It’s a microcosm of the bigger picture economic problem we all face right now. There is too much oil in the world. That has been brought to a head by the coronavirus resulting in a collapse in demand. But it’s been brewing for some time.

It’s perfectly normal for “hard” commodity prices to undershoot and overshoot. It takes time and money to find and produce oil or other resources. You need to get permission to explore, then you need to explore, then you need to find something, then you need to get permission to dig or to drill, then you need to dig or drill, then you need to shift it from one place to another – it’s a monumental undertaking.

So the industry is always out of sync with the underlying cycle. Demand outweighs supply so prices go up. Suppliers notice prices going up, so they try to produce more. That takes time, so prices keep going up. Eventually though, there’s a glut as supply all comes online at roughly the same time. Prices fall, producers cut back, and so the cycle goes round and round.

But for oil on this occasion, there’s been a bit of a glitch. The rise of US shale has turned everything upside down.

US shale came about in the first place because in the run up to the 2011 commodities peak, oil prices soared. It became worth looking for oil anywhere you could find it, because we were approaching “peak oil” – we were running out. $100 oil made almost any source viable.

However, while expensive oil might have kicked off the shale revolution, something quite different has kept it going – low interest rates and cheap credit.

As a result, shale oil producers have been able to keep going even although the vast majority of them don’t make any money. This is an industry that would have mostly closed down by now if it weren’t for the wildly forgiving monetary backdrop that we are operating against.

This means we have a group of essentially price-insensitive producers battling it out to be the last man standing. And this is how you end up getting something as ridiculous as negative oil prices.

We’re destroying the fabric of capitalism

This is all symptomatic of a bigger problem that we have right now.

In his Bloomberg newsletter this morning, John Authers takes a look at a recent report from Jim Reid at Deutsche Bank. Reid takes a look back at historical default rates – companies going bankrupt – in the US since 1970.

To cut a long story short, even although credit quality has been getting worse (and it's very bad right now), default rates – even during recessions – have been going down. Why?

Because, as Authers puts it, “taxpayers are prepared to do far more to prevent defaults.” In other words, the bailouts keep getting bigger and bigger.

Here’s the problem with that. And I know I’m repeating myself, but this is important.

The reason we have free markets and capitalism is because they have proved to be one of the best methods of allocating scarce resources that we have yet uncovered (note that being better than other methods does not imply perfection – just superiority to other methods thus far tried).

If resources are put to good (efficient) use, then they will turn a profit and the business or industry will attract further resources until it stops being profitable. If the resources are not put to good use, then they won’t turn a profit. That will lead to bankruptcy, which then leads to the redeployment of said resources by someone who thinks they can do a better job.

The point of bankruptcy is not to ruin people’s lives or to cause depressions. The point of bankruptcy is to allow resources to be put to better use. That’s it. (This is why bankruptcy laws shouldn’t be punitive and why unemployment safety nets should be generous, but this is a topic for another day).

Bankruptcy helps us to see what’s working and what isn’t. If you effectively get rid of bankruptcy, then bad ideas thrive. In fact, it’s worse than that. The good ideas end up being suffocated under the sheer weight of all the bad ideas out there, because bad ideas are generally easier to pursue than good ideas.

How do we know that this is a problem? Because as Authers points out, Reid highlights a clear relationship between corporate default rates and productivity.

“The positive side to defaults, if there is one, is that it stops inefficient businesses from draining capital, and allows banks and investors to look for projects that have a better chance to grow,” writes Authers.

"An environment with ever lower rates and predictable intervention to avert defaults is also an environment in which we might expect productivity to endure a steady decline. And Reid’s numbers suggest that that is exactly what has happened.”

This is what happens when you persistently ignore moral hazard. If you avoid consequences today then you end up with bigger consequences tomorrow.

This is depressing. But it’s also human. We all do it. That’s what makes it so predictable. If you want to know which option society will choose on average, then you simply go with the path of least resistance. And the path of least resistance is always the one with the fewest short-term consequences.

Eventually, we’ll switch to another path. But it’ll be because the short-term pain becomes too great for us to continue on the current path. And that’s why I think that we keep going down this route until an inflationary crisis forces us off it. And that’s not for a while yet.

So expect financial repression, increasingly overt deficit monetisation, and all that good stuff. And as for oil prices – well, I imagine they’ll shut down production completely at precisely the wrong moment, as that’s what usually happens.

For more on all this, and its impact on your portfolio, do subscribe to MoneyWeek magazine. Your first six issues are completely free and we’re also giving away a free ebook on some of the biggest crashes in history – some of it might provide a useful guide as to what will come next.

The oil price fell by more than 250% yesterday. Yes, you read that correctly. The oil price started the day at a bit below $20. By the end of the day, the price had turned negative. And it closed the trading day at -$37.63 (although at one point it went below -$40).

I know you’re fed up with the word “unprecedented” so I’ll just say: this has never ever happened before. (As if you needed to be told that). So let’s answer the obvious question first – what on earth is going on?

Why the price of oil (well, a specific type of oil) has turned negative

First things first – don’t get too excited.

The oil price that matters is not negative. You and I will not be getting paid to fill up our cars when we finally get out from lockdown. This morning, Brent crude oil (the European benchmark) is trading at around $18 a barrel (which is down by a pretty hefty 20% or so, but not negative by any means).

So which oil price are we talking about? I’ll come back to that in a moment. But first, let’s take a look at the “big picture” problem here, so we have a firm view on the background before we get to the technical stuff.

The core problem for the oil market is this: the coronavirus means that economic activity around the world has taken a massive hit. So we’ve seen an extraordinary plunge in demand for oil. Hardly any planes flying around, a lot fewer cars driving about – you can see the problem.

Meanwhile, the supply of oil hasn’t dropped by anywhere near as much as demand. In fact, until very recently, when they made a half-hearted deal to cut production, oil producers were hell bent on pumping as much as they could because of various attempts to stiff their competition (the Saudis and the Russians want to bankrupt each other and the US shale producers, basically).

So loads of oil is being pumped, but much less than usual is being used. What does that mean? It means you need somewhere to stick all that unused oil.

Now, as any MoneyWeek reader who owns physical gold will know, storing a “real” commodity costs money. You need a safe place to put it, you need insurance, you might even need to pay to move it from A to B.

And the thing is, gold isn’t a volatile, toxic substance that can only be safely handled by professionals. At the end of the day, you can bury gold in a hole in your back garden if you want to. Can’t do that with oil. Oil requires specialised storage. And there’s only so much of that to go around.

So that’s your overarching problem. We’ve got a lot more oil than anyone can use, and storage space for the spare oil is running out. Or to put it differently, you suddenly have a lot of demand for oil storage, and not enough supply.

But how did we end up with a negative oil price in this specific instance?

OK. Here’s where it gets a bit more fiddly, and I’m going to ask for forgiveness if I mangle or over-simplify this explanation (expert comment welcome at editor@moneyweek.com – put “Schoolboy error” in the subject line so I can spot it).

A beginners’ guide to the oil market

Let’s talk about how oil (and most other commodities) is traded.

When you buy shares on the stock exchange, you take ownership of the shares. You buy or sell via your stockbroker, and then through lots of backroom processes that you don’t usually need to worry about, ownership of said shares transfers from the previous owner to you. You buy the goods and you take delivery – even if it’s just a digital good.

Oil is different. Oil is mostly traded using futures contracts. These are agreements to buy (take delivery) or sell oil at a specific price on a specific date in the future. They “expire” on a monthly basis, at which point the party who owns the contract takes delivery from the party who wrote the contract.

The price of oil you’ll hear quoted in the news is generally the price of the “front month” contract – the one that’s most current. But there are lots of different contracts – for example, right now you can agree to take delivery of Brent crude at a price of around $30 a barrel at the end of September.

If you need physical oil – you run an airline or an oil refinery, say – then you can buy futures in order to lock in a price and have some certainty about your costs. But some people just want to bet on the oil price. They don’t ever want to take physical delivery of the oil itself, they just want exposure to its ups and downs.

So at the end of the month, these people would normally just sell the contract that’s about to expire, and buy the next month’s (they “roll over” the contract).

So that’s a very rough explanation of the futures market. (We’ll park the terms “contango” and “backwardation” for now).

There’s another point to highlight. As we briefly noted above, oil comes in lots of different types – it’s not a universal market like gold, say. So when we talk about the oil price, we usually mean the European/international benchmark (Brent) or the US benchmark (West Texas Intermediate or WTI – the one that turned negative). There are key differences between these, which help to explain why WTI crashed so hard.

So here’s what happened yesterday. The May contract for WTI was due to expire today, whereas Brent was already on the June contract. That’s the first issue. It meant that anyone holding the WTI May contract either needed to be ready to take delivery of the oil, or needed to sell the contract to someone who was willing and able to do so.

This is where the differences between Brent and WTI come into play. Brent is a “seaborne crude” as the Financial Times puts it. If you are short of storage space, then you can rent a big oil tanker, and just leave it floating around. You then profit by selling the oil further down the line.

Yes, I know that sounds drastic – it’s not exactly hailing an Uber – but it can be very profitable, as long as you can get a tanker at the right price. Of course, because there’s a shortage of places to store oil, it means that the cost of renting a supertanker is going up, which is great for companies who own the supertankers in the first place. But that’s another story for another day.

The problem with WTI is that it’s inland and there’s only one place to deliver it – the oil hub of Cushing in Oklahoma. And storage in Cushing is full – or at least, any spare capacity has already been rented out.

So, long story short – if you held a May contract for taking delivery of WTI oil and you had nowhere to put it, you were stuffed. So if you wanted to get that contract off your hands, you had to pay someone to take it, in some cases as much as $40. And if you then wanted to roll over into the June contract, that would have cost you $20.

So you made a loss of $60 to roll over your bet on crude oil. Most of the time that rollover cost would be a couple of dollars tops. In other words, it would have been an absolutely catastrophic trade for anyone on the wrong end of it. This is why some people think we’ll hear about hedge funds or other players going bust in the next few days (though that depends on whether or not America’s central bank, the Federal Reserve, has already stepped in to save them).

Hang on to oil stocks but be prepared for a rough ride

So what does all of this mean? Firstly, it’s a valuable reminder that you shouldn’t invest in anything you don’t entirely understand because if you get caught unawares the consequences can be much nastier than you expected.

Secondly, it points to just how spectacular the disruption in the oil market currently is. On the one hand, the oil price hasn’t actually gone negative. What actually happened is that the price of a specific type of oil, due to be delivered to a specific geography, on a specific date, turned negative.

But the fact that this happened at all points to the weird territory that we’re in. And the aftershocks are looking pretty brutal this morning. Both Brent and WTI are sliding hard – Brent is down about 23% as I write.

That’ll be because, as Louis Vincent-Gave points out in Gavekal, the obvious question now is: why wouldn’t the same thing happen again next month? After all, production has not collapsed and storage capacity is not going to suddenly rocket in a month.

And a third thing is clear – the resurgence in the oil price that we saw after the much-heralded deal between the US, Saudi Arabia and Russia to remove production from the market has been well and truly hammered.

I’d still hang on to your oil majors – they are cheap, and this kind of oil market havoc is only going to bring the point at which production really does collapse much, much closer. But be prepared for a rough ride.

We’ve already run on for too long today but there are plenty of other consequences from all this, as well as interesting potential opportunities. I’ll look at those later in the week. We’ll also be picking up on the story in MoneyWeek magazine in the next few weeks – subscribe now to get your first six issues absolutely free.

“The short, violent oil war of 2020” is over, says Noah Rothman in Commentary magazine. Producers led by Saudi Arabia and Russia launched an all-out contest for market share last month, triggering a supply surge amid historic virus-induced demand destruction. Yet with prices plunging to 18-year lows of $23 a barrel the pain proved too great.

Producers in Opec, the oil exporters’ cartel, along with Russia (“Opec+”) have now agreed to restrict output by ten million barrels per day (mbpd) from next month, about 10% of global supply. Norway, Canada, Brazil and the United States should deliver five million mbpd in additional cuts.

Too little, too late

Crude prices barely budged at the start of the week despite the historic scale of the cuts, say Myra Saefong and Barbara Kollmeyer on MarketWatch. The price of black gold has bounced off its March lows, with Brent crude now around $30 a barrel. After weeks of a “damaging price war” the new measures appear to be “too little, too late” to rescue prices, which have crashed by more than 50% since the start of the year.

The cuts don’t look so impressive against the “untold numbers” of cancelled commutes, plane trips and cargo shipments triggered by the virus shutdown, says Clifford Krauss in The New York Times. Global oil demand is down by somewhere between 25-35 mbpd, up to three-and-a-half times more than the new cuts. That means that even in the unlikely event of Opec+ nations fully adhering to their pledges the market will remain in sizeable surplus in the second quarter, says Caroline Bain of Capital Economics.

Yet the second half of 2020 could be more positive. If economies return to work and US shale production drops off as forecast demand could outstrip supply later this year. The US shale industry is certainly having a difficult time, says Krauss. Shale oil wells in Texas and North Dakota need prices above $40 a barrel to turn a profit. The industry is “decommissioning rigs and fracking equipment and laying off thousands of workers.” Some supply will be permanently removed from the market.

It remains to be seen how long the deal holds, says The Economist. Sustained output coordination across an “unwieldly cast” of Opec+ and G20 states will prove difficult. Non-compliance could quickly cause the accord to unravel, while market watchers note that state-owned Saudi giant Saudi Aramco is shipping oil to Asia at steep discounts in order to maintain share in a vital market. “The global oil-price war is not over, but on hold”.

A short reprieve

“Opec looks just as dysfunctional as before”, agrees Lex in the Financial Times. Analysts have warned that oversupply threatened to overwhelm global supply capacity next month, yet this output deal will only postpone “serious supply and demand imbalances for a month or so”. Brent crude probably hit a bottom last month but the chances of any “sustained rally” from here seems “vanishingly slim”.

The oil price has collapsed this year. It’s all about coronavirus and price wars.

Oil on both sides of the Atlantic is now trading at levels not seen since 2002.

And yet some argue that oil could go even lower. Eventually, producers might be paying consumers to take it off their hands.

Oil is being hammered by both supply and demand issues

Oil is being battered at both ends. On the supply side, Saudi Arabia and Russia initiated an oil price war just as the coronavirus was turning into a global emergency. As a result, the market is being flooded with more oil than ever before.

The motivations of the parties involved are not necessarily clear, but one side effect is to make life very difficult for oil producers in the US. As the FT reports, US energy producers last week made “the biggest cut to the number of drilling rigs operating in five years”, according to the latest Baker Hughes figures.

The US is currently the world’s top oil producer, ahead of Saudi Arabia. But that might not last if the country is forced to slash production as low oil prices continue.

The other massive problem is on the demand side. Coronavirus means that people have virtually stopped flying. Budget airline EasyJet this morning announced that it has grounded its entire fleet and furloughed (the jargon word for temporary redundancy) most of its crew as a result.

People have stopped driving too. Apparently global petrol demand could halve in certain markets, according to analysts quoted in the FT.

(Also note that – while it has nothing to do with oil demand – electricity demand in the UK fell by about 10% last week, and a whopping 30% year-on-year, as the lockdown keeps most people at home. That saw wholesale prices fall too, which naturally might take a while to feed into your domestic electricity bill).

Overall, says the FT, analysts reckon that as much as a quarter of normal global consumption could be lost.

Another problem is that we are running out of storage space for the spare oil. Analysts suggest that at current storage capacity we have months or perhaps weeks before storage space is full. That leads to the idea that we could even at some point see a negative oil price – where people are literally paying others to take it off their hands. That seems nuts – that would be nuts – but the fact that this is even being floated as a possibility gives you some idea of how much oversupply we’re currently looking at.

What does this all mean for investors?

What are the implications?

In a more normal world, prices would fall. Demand would rise as a result (when petrol prices fall in the US, for example, people drive more and buy bigger cars), and so prices would rise again as supply and demand balanced out.

That can’t happen this time. Demand can’t react because it is shut in, and supply isn’t reacting because the dominant producers want to put the shale upstarts out of business.

So on the oversupply side, it looks to me that the shale industry will be the big casualty. With the market less keen to invest in risky debt it seems hard to believe that at least some of them won’t go to the wall. As Francisco Blanch of Merrill Lynch tells the FT, “capital markets are now shut to the shale sector”.

On top of that, investors were already becoming wary of the oil sector given the whole rush for ESG (environmental, social and governance) investing, and fears about stranded assets. The current rout will just make them even queasier. And while oil might be a strategic asset for the US, can the government really go in and bail out the whole sector? It seems unlikely. The US is open to topping up its strategic reserve but that can only suck up so much excess oil.

So I’d expect shale to give way first. The Russians are being described as the most capable of enduring a long, low oil price, while the Saudis need much higher prices to fund their public spending. But if they both think that they might get rid of the competition from the US, then they may both feel it’s worth hanging on.

What about the demand side? In terms of what the problem is and what the solution is, it’s very clear. Once lockdown measures end and as coronavirus recedes as a threat, oil demand will return. It may bounce back, or we may be a little more circumspect. Some may not travel as much (maybe we’ll realise we don’t need to be in the office every day) and some might change their habits on an ecological basis.

But I think these behavioural shifts will be relatively minor factors. The majority of people aren’t lucky enough to be able to work from home on a permanent basis. And once this is all done I think people will want to go on holiday again. So I can see demand recovering to something approaching normal in the longer run.

OK. So on the supply side, Russia and Saudi Arabia may or may not keep pumping. The quicker US shale producers give up the ghost, the more likely they are to pull back production. On the demand side, meanwhile, it’s all about coronavirus and the containment measures.

So what does all of that imply for investors?

If you’re going to buy oil, I’d stick with the oil majors. They should have the firepower to survive this downturn, but don’t be surprised to see dividend cuts. The oil price itself could go yet lower, although there does come a point where even Russia and Saudi Arabia might think twice (like, when oil prices genuinely look as though they might go negative).

In terms of a recovery – as with many other things at the moment, the key variable is the coronavirus. If it goes away quickly, demand will go up and prices should follow (because even if supply remains ample, the market will start to be less oversupplied, if nothing else). If we’re sitting on minimal demand for months and months though, oil prices could be stuck here or even below for some time.

We’ll have more on this in the next issue of MoneyWeek magazine – get your first six issues free here.

“Now comes the oil shock,” says The Wall Street Journal. A “game of chicken between Riyadh and Moscow” has sent oil prices plunging and produced the worst day for many equity indices since 2008. Major oil producers led by the Saudis and the Russians, a grouping known as “Opec+”, have been cooperating to limit output and support crude prices since 2016. The Covid-19 demand slump saw Opec propose a new 1.5 million barrels per day (bpd) cut. That plan was rejected by Moscow, which has grown critical of an approach that it says only props up prices for US shale producers.

A nasty break-up

Rather than compromise, Riyadh retaliated. The Saudis slashed prices over the weekend in an all-out attempt to steal market share. The resulting “price war” could see the global market saturated with oil. Caroline Bain of Capital Economics predicts a “huge” global surplus of 3.2 million bpd in the second quarter.

The dramatic dissolution of the Opec+ alliance saw crude prices plunge by the most since the 1991 Gulf War on Monday. Brent crude fell 24% and is down almost 50% this year to trade at around $35 per barrel. US benchmark West Texas Intermediate had its second-worst day on record, losing 24.6%. Oil companies account for 10% of the UK equity market. The FTSE 100 had its worst day since the financial crisis on Monday, plunging 7.7%.

The International Energy Agency forecasts that demand will fall by 90,000 bpd this year, the first annual decline since 2009, says Andy Critchlow in The Daily Telegraph. Industry veterans fret that the “high-stakes game of roulette” between Moscow and Riyadh could see oil “tumble below $20” per barrel. The Saudis do not seem well-placed to win a price war: they need prices at $80 a barrel to balance their budget. Russia, with a more diversified economy, says it only needs $40.

The downsides of cheap oil

This high-stakes strategy is typical of Crown Prince Mohammed bin Salman, Saudi Arabia’s de facto leader, writes Julian Lee on Bloomberg. The prince wants to “drive oil prices down so far and so fast that Russia realises it made a terrible mistake”, but that is unlikely to work. As with the prince’s bloody intervention in Yemen, a supposedly short decisive blow could turn into a protracted conflict that does damage to all sides. The prince is “a risk taker... prone to impulsive decisions”, Greg Brew of Southern Methodist University told The New York Times.

Yet why is cheaper oil bad news? Historically, lower prices have been seen as a “net positive for global demand” as they boost consumer purchasing power and lower costs for businesses, says Jennifer McKeown of Capital Economics. Yet with coronavirus causing lockdowns and sowing fear, consumers are unlikely to rush out to spend. Oil-producing companies and nations are in for a serious budget squeeze. “What’s more, the price crash could put severe financial stress on the corporate bond market.”

Is the corporate credit bubble about to meet its pin?

The bill for America’s energy boom could now be due. Shale energy firms have borrowed billions of dollars over the past decade to finance the exploration and drilling of thousands of wells, says Ryan Dezember in The Wall Street Journal. In a world of ultra-low interest rates investors were delighted to snap up the higher yields on offer.

Moody’s Investors Service reports that North American oil and gas firms have $200bn in debt maturing over the next four years. And now slumping oil prices are sending jitters through the bond market. On Monday energy bonds issued by smaller operators traded so low that the market seemed to have concluded they were “already out of money”. Around 12% of the $936bn of debt issued by US oil and gas firms are trading at distressed levels, notes Joe Rennison in the Financial Times: their yield is more than 10% above that of US Treasuries.

This story is bigger than US energy, says Alexandra Scaggs in Barron’s. Energy bonds make up about 11% of the US high yield debt market. Energy sector ructions have prompted investors to pull a net $9.3bn from junk bond funds over the last two weeks. That is driving up borrowing costs for all junk bond issuers. The spread of financial contagion to the wider high-yield bond market looks “inevitable”, said Deutsche Bank in a note.

Firms grappling with record levels of corporate debt could now be hit by falling earnings caused by Covid-19 on the one hand and rising borrowing costs as bond markets take fright on the other. The OECD notes that BBB-rated bonds, one notch away from junk, made up 52% of all new investment-grade bond finance worldwide over the past three years, says Philip Aldrick in The Times. Junk bonds comprise another quarter of corporate debt. What’s more, the International Monetary Fund said late last year that the money owed by companies unable to cover interest payments with profits could hit 40% of the total in eight major economies if there is a downturn half as bad as the financial crisis.

In short, concludes Aldrick, we could be in trouble. US economist Hyman Minsky argued that a fall in one set of asset prices can act like a domino that knocks over “the whole debt-funded capitalist edifice”. Corporate debt could prove the “first domino.”

What oil’s plunge means for investors

The collapse in the oil price has wrought havoc on the share prices of oil companies everywhere – with double-digit drops in the share prices of FTSE 100 stalwarts BP and Royal Dutch Shell, and the spreads on US shale oil companies debt exploding higher. So what does it mean for your portfolio?

The first question is: will the oil price stay here, or perhaps fall further? This depends on several factors, none of which look especially promising for oil bulls. On the demand side, coronavirus will have a huge impact. The International Energy Agency reckons that global oil demand will fall this year for the first time since 2009. On the supply side, Saudi Arabia and Russia have flung the taps open, with Saudi upping the stakes even further mid-week, by saying it aims to pump 13 million barrels a day – a record level. The hope might be to put US shale producers out of business, but that will take time, especially if the US steps in to defend the sector. So in the short-to-medium term, it does look as though low prices are here to stay.

But what does this mean for oil producers? It’s certainly not good news, but on the other hand, oil producers were already being shunned by global markets. As a proportion of the S&P 500 for example, the energy sector has never before been this lowly valued. Part of that is scepticism over shale producers ever making any money (quite possibly justified) but some of it is arguably down to over-optimism on how rapidly we’ll replace fossil fuels with less polluting resources. So oil companies were dropping from low valuations.

The outlook for US shale producers looks too uncertain for our liking. But the oil majors look more interesting. As Rupert Hargreaves notes on Motley Fool, BP (LSE: BP) has a healthy balance sheet with low borrowing and plenty of scope for cutting spending if necessary. The majors have also demonstrated in past crises (such as the 2014 slump in the oil price) that maintaining their dividends is of utmost importance. With BP currently yielding more than 9%, that looks worth betting on. Shell (LSE: RDSB) has a higher breakeven cost of production but it’s also viewed as unlikely to cut its dividend.

Meanwhile, a slump in the oil price is unequivocally good for some sectors and countries – cheap petrol is good news for consumers and it’s very good news for the beleaguered travel industry in general. The difficulty is that low oil prices are unlikely to benefit the latter immediately – it’s still not clear just how badly damaged airlines and cruise companies will be by the slump. If you are feeling very brave you might want to consider a small dip into cruise giant Carnival (LSE: CCL). It’s currently yielding more than 9% – we wouldn’t bet on that being paid out, but given that the US government has been making noises about assisting the travel industry, it might be worth a bet.

We’ve all woken up to rampant panic in the markets this morning. If you hadn’t read any headlines yet, you might think this was down to some dramatic mutation in coronavirus. But today’s panic is only tangentially linked to the bug.

Today we’re panicking about an epic plunge in the price of oil.

Saudi Arabia and Russia declare an oil war

When markets opened this morning, the price of Brent crude – the European benchmark price for oil – dived by nearly a third, to as low as below $32 a barrel.

I know that you probably don’t follow the oil market quite as closely as the stockmarket, so for the avoidance of any confusion – that is extraordinary. We haven’t seen the oil price crash this hard since 1991.

That was the start of the first Gulf War, arguably the last war in the Middle East that everyone broadly understood and largely felt was justified. Iraq under Saddam Hussein invaded Kuwait, and America pushed back.

Why did oil prices crash, given that a war could presumably only hinder supply? Because the US opened up its strategic reserve and effectively flooded the market. And something similar has happened this time around.

Oil prices have been hit by fears over global recession, induced by the coronavirus. Hence, the bug has brought the tensions in the oil market to a boil. Saudi Arabia-led oil cartel Opec and Russia – the biggest non-Opec oil producer – have been tentatively co-operating to keep the oil price from collapsing under the weight of US shale production.

They had been expected to announce further production cuts at the end of last week in order to keep the price from succumbing to coronavirus. That didn’t happen. Instead, to cut a long story short, Saudi Arabia and Russia fell out.

On Friday, Opec talks broke down. And over the weekend, Saudi Arabia slashed prices to its customers and said it would ramp up production. Russia similarly unleashed its own oil producers.

What’s the point? Mostly, to flood the market, steal market share from each other, and kill off US shale production where at all possible. There’s also the added bonus (for oil producers) of pushing back on the rush to electric cars by making petrol an awful lot cheaper.

There’s an added, slightly esoteric geopolitical twist in that oil is one of the key underpinnings of the current global monetary regime. Russia in particular would like to undermine the role of the US dollar as the global reserve currency, and crashing the oil price helps in that goal. (We’ll talk about this a bit further down).

The secret to making money in a crash is to have money when no one else has

Anyway, it’s causing havoc in markets right now.

At the time of writing, shares in the UK have tanked to below 6,000 on the FTSE 100. US shares look set for similar falls. That official bear market – the 20%-plus correction that hasn’t happened to the S&P 500 since 2009 – is about to land.

I’m going to sound like a stuck record here, but the worst thing to do today is to panic. Sit tight. Or if you have been preparing a watchlist of things you’d like to buy, it might be a good time to get it out.

If you must look at your portfolio, try to do it with some objectivity. It’s going to look ugly. But don’t make hasty decisions.

For example, do I think that BP should be down 25% this morning? I don’t know. But while I’m not hitting the “buy” button right now, I certainly wouldn’t feel confident about selling at this level. Is this really more of an existential threat to BP than the Gulf of Mexico disaster was in 2010? Not convinced.

What you probably do need to be aware of as an individual investor is that big moves like this tend to break things. Elaborate or illiquid things tend to blow up as levels that no one ever expected to be breached, are breached. If you have money in funds or ETFs that you don’t really understand, today might end up being a learning experience.

I’m also keenly aware that – as we’ve noted a few times recently – the corporate debt market is overstretched. And the most overstretched sector in that market is the energy sector. In 2015, there was a panic over energy junk bonds. In the absence of some sort of intervention (which I wouldn’t put past the US government), we could see a blow-up in that area.

The other point is that when fragile things break, other things – even “anti-fragile” ones, to use Nassim Taleb’s term – suffer the knock-on effect. Sometimes this can prove to be a buying opportunity. There are few things better than being someone with ready cash available in a market stuffed full of forced sellers.

That – fundamentally – is Warren Buffett’s secret. He’s always got money when everyone else needs it. Hopefully you do too.

On a wider basis, a steep fall in the oil price is not necessarily a bad thing.

It’s good for airlines, who’ll get much lower fuel bills (depending on their hedging strategies), although at this point that’s a bit like chucking a sticking plaster to someone who just tangled with the business end of a combine harvester.

It’s good for consumers. They don’t feel like spending right now, so any sign of an improvement in the coronavirus spread might change that, although not for a while.

And the deflationary collapse in bond yields means that interest rates aren’t going anywhere for now. For the first time ever today, UK bond yields have turned negative. That’s right, people are willing to pay our government to lend it money. That’s the same government that’s on the brink of a serious spending splurge.

If nothing else, that’s going to keep mortgage costs down.

So if you can be patient and hold your nerve, you should be more capable of spotting where the market is pricing in too much disaster. It does feel like this is one of those days.

The days of the US dollar standard are numbered

At a deeper level, I entirely agree with Bloomberg’s John Authers when he writes this morning that “the world has at last arrived at a point that it appeared to have reached a decade ago. Some new financial order, to replace Bretton Woods and the system that [Paul] Volcker built to replace it, is now needed.”

I’ll discuss this in more detail at some point, but since 1971, when Richard Nixon severed the dollar’s link to gold, the world has effectively been on some form of “dollar” standard. Oil has played a big role in the mechanics of that, as has faith in central banks.

Shale production and effective US energy independence has upset that apple cart in ways that no one fully understands. And faith in central banks has been eroding since the global financial crisis. This might be the point where all of that comes to a head.

Again, I know I keep saying this, but this is why we own gold in our portfolios. It won’t go up every day and it might even crash in this environment (when you need liquidity to meet margin calls, you sell your most liquid assets – that’s when money moves from “weak hands” to “strong hands”). And if everyone decides that today is a climactic panic – doesn’t feel like it this morning, but you never know – gold will succumb in any return to “risk on”.

But gold has a longer record than any other asset of being at or near the core of the financial system. So if that system is going through a generational shift, then it’s a good idea to own some.

And subscribe to MoneyWeek magazine if you don’t already. I like to think that we might help you to stay on the straight and narrow through all of this. Get your first 12 issues for a measly £12 here.

Happy New Year!

It's always good to start a new decade on an optimistic note.

So coming back to headlines fretting about World War III is perhaps not the best way to start the year.

The latest on the Cold War in the Middle East

At the end of last year, I said that I reckoned that oil would be one theme to watch in 2020. But I'll admit I didn't expect it to be grabbing headlines quite as early on in proceedings.

Long story short as you're probably already aware of what's going on on Friday, Iranian general Qasem Soleimani was killed in an airstrike at Baghdad airport. The airstrike was ordered by the US.

Soleimani was the head of the Iranian Revolutionary Guards' Quds Force. It's considered a terrorist organisation by the US, and the US says that Soleimani was "actively developing plans to attack American diplomats and service members in Iraq and throughout the region". The airstrike also followed an attack on the US embassy in Iraq.

Now, let me make one thing clear before we go any further: I'm not an expert on Middle Eastern politics and, unlike lots of people on Twitter, I feel no need to pretend to be. I hadn't heard of this guy until this happened.

My broad understanding of the Middle East is that Saudi Arabia and Iran are at loggerheads, and they are effectively engaged in proxy wars across the region. Yemen and Syria are two examples.

Overlaid on that, you have the US, whose interests are broadly aligned with those of the Saudis (although increasingly less so, because the US is now energy independent), and the Russians, whose interests and sphere of influence broadly aligns them with Iran.

Whatever you think of what's going on here, or who did what and where, and who the "goodies" are and who the "baddies" are, one thing is reasonably clear to a non-expert eye: things are hotting up in the Middle East, which is still a hugely important area for global oil production.

In turn, that suggests that the relative complacency that hung over the oil market last year is likely to disappear this year. Particularly if the demand side holds up better than many investors fear.

So what happens now?

This does not mean war not outright, in any case

Tom Holland (no, not that one and no, not that one either) of Gavekal argues that, for all the headlines, this doesn't represent the sort of escalation that the papers are fearing.

On the one hand, the US feels that diplomacy has failed to contain Iran. The nuclear deal collapsed ages ago. Meanwhile, sanctions aren't squeezing the regime to change its mind. Nor are they fomenting the kind of anger required for internal regime change to take place.

On the other hand, the US does not want to get involved in any more open wars in the Middle East. At least one factor behind Donald Trump's election was a desire on the part of the US populous to put Iraq and foreign wars in general behind them.

A core part of "America First" as an ideology, is an end to "Pax Americana". Let the rest of the world sort out its problems America's got enough to be getting on with at home. I wouldn't underestimate how important that is to Trump's core voters.

So, argues Holland, getting rid of Soleimani was the best of a bunch of bad options as far as the US goes. And on the Iranian side it's one thing to threaten retaliation, or to consider shutting down the Strait of Hormuz, but it's quite another to go through with it. For all that the US is reluctant to go to war, there's no question who would "win" if it came to all-out warfare.

As Holland puts it, "the very reason Tehran has sought to extend its regional influence through the asymmetric methods championed by Soleimani is precisely because it cannot take on the US directly".

In turn, he argues, this means that "the risk premium being priced in by financial markets is likely to remain limited with oil remaining in its 14-month range capped at $75 per barrel for Brent and to abate over time, at least until the next flare-up".

Markets are still too complacent on oil

I suspect that Holland's analysis is probably accurate in terms of the risk of a big conflagration. However, I'm not so sure about the argument on the risk premium or at least, the idea that oil prices will be capped.

The last big surprise was the drone attack on Saudi Arabia's production. The oil price spiked, then almost immediately came back down. We may well see a similar pattern here, but we can almost certainly expect more incidents.

And in any case, there are quite a few other factors that could mean there is less oil than required hitting global markets this year. Shale oil production growth appears to be slowing. That's partly because the producers are struggling to fund themselves. And that's before we get to any surprises on the demand side.

In short, I'd maintain exposure to the oil production sector. There's still too much complacency out there. We discussed just how much complacency in our New Year roundtable in MoneyWeek magazine if you missed it, subscribe now to get your first 12 issues for just £12.

Oil has hit a three-month high above $65 a barrel following Trump's China trade deal. That is a level not seen since September's drone attack on Saudi Arabia briefly knocked out some 5% of global supply.

Brent crude is up about 21% for the year, but still below April's 2019 high of $74.5. Oil bulls were given further cheer when Saudi Aramco's stock briefly soared above the symbolic valuation level of $2trn on the Saudi Tadawul index, notes Avi Salzman for Barron's.

Yet Bernstein analysts reckon that at current prices the company is worth closer to $1.36trn. Political influence makes it "hard to argue that Aramco's current price is a true market price'".

Oil exporters' cartel Opec gave further encouragement to the bulls this month after agreeing to new production curbs, says Sarah Toy in The Wall Street Journal. The oil cartel and allies will cut output by 500,000 barrels a day until April, adding to an already existing 1.2 million barrels per day cutback.

Yet the oil rally stalled at the start of this week because of scepticism over whether the deal will truly reduce global supplies next year. Nigeria and Iraq are already struggling to honour existing commitments.

The International Energy Agency expects global oil inventories to rise by 700,000 barrels per day in the first quarter of 2020 due to weak global demand and rising output in non-Opec states. That could keep a lid on oil.

The price of oil spiked by a fifth at one point this morning.

Brent crude surged by nearly $12 a barrel, to more than $71. It's eased back since then but it's still up by more than 10%.

You don't see those sorts of moves every day.

But then, nor do you see half of Saudi Arabia's oil production knocked out of action every day.

How half of Saudi Arabia's oil production was knocked out

On Saturday, Saudi Arabia's oil infrastructure was attacked.

I'm an expert on neither oil treatment plants nor military hardware (this isn't a Tom Clancy novel), so I'm not going to get technical here, and I apologise to the many engineers among our readers if I get anything wrong.

But long story short, oil needs to be treated before it is ready for export. The Saudi facility, Abqaiq, is a key part of this process, removing impurities. If it doesn't get treated, the oil can't get to market.

What happened is that some vital bits of the Saudis' treatment infrastructure at Abqaiq were knocked out by a series of drone strikes. These strikes were apparently extremely accurate.

Who did it? Saudi Arabia has been waging war in Yemen for four years now. Houthi rebels there claim responsibility for the Abqaiq attack, saying that they pulled it off a swarm of ten drones. And they have been using drones to make similar attacks in the last year or so.

But the US is sceptical about this, and it's pointing the finger at Iran. We could burrow deep down into a conspiracy theory rabbit hole at this point, but there's no point. I don't know for sure who did it any more than you do, but Iran certainly isn't a huge fan of Saudi Arabia, and seems a likely contender.

Anyway, as a result, about half of the country's crude oil output has been knocked out of action. That's not far off six million barrels of oil a day, which in turn represents about 5% of global oil supply.

Hence the double-digit spike in the oil price this morning. We haven't seen this sort of thing since the invasion of Kuwait by Saddam Hussein in 1990. Which of course, has uncomfortable parallels as to what might occur next.

Could this be the pin to prick the bond bubble?

So what happens next for oil prices? There are two main issues to consider on that front. First, there's the practical question of how quickly the Saudis can get things working again. That will become clearer over this week. In the meantime, both the US and Saudi Arabia have oil reserves that can be used to tide the market over.

So the initial spike is a shock reaction. The actual disruption to supply may be less extreme than it appears. However, the more complicated second factor is the "risk premium" that now gets added to the oil price.

The problem is that this attack opens up a whole host of unpleasant new possibilities. If a small swarm of drones can cripple key oil facilities, then what's to stop this from happening again? And what if it escalates? We've already got the US pointing fingers at Iran. Are we going to see yet another Gulf war? You would hope not, but who knows?

Beyond oil, on a wider scale, there's the question of what higher oil prices do to inflation and inflation expectations. Last week, I noted that James Ferguson of the Macro Strategy Partnership has been flagging up the close relationship between the oil and gold prices, and consumer price inflation.

In a note from Gavekal this morning, Louis Gave notes that the bond bubble has been sustained by the idea that inflation is "dead and buried". This is, in itself, not true indeed, inflation "has been creeping higher, despite a strong US dollar and a weak oil price".

A spike in the oil price could be just the event to shake up a market that has, until now, been fixated on the threat of a deflationary crisis. "The renewed threat of war in the Middle East, the potential destabilisation of Saudi Arabia, and a possible conflict between Saudi and Iran all highlight the immediate risk that the next shock to the system could actually be inflationary."

An inflationary shock in a world positioned for relentless deflation? That's going to wreak havoc on an awful lot of portfolios.

It's yet another variable to throw into our current volatile geopolitical mix. And it'll be yet another thing for us to discuss at the MoneyWeek Wealth Summit on 22 November (James Ferguson will be among the many panelists, so he can give us all his latest views on oil then) don't miss it.

Quick note to MoneyWeek subscribers: if you haven't booked your ticket for the MoneyWeek Wealth Summit yet, then have a look in this week's issue of the magazine when it hits your doorstep there's a special subscriber discount offer. We'll also be announcing more guests very shortly keep an eye out for that.

Equity and bond markets have calmed down a little after the drama of earlier in the week.

There's not a hugely obvious reason for this beyond the fact that markets can only sustain so much panic before they get tired.

So let's quickly turn to another key asset that took a hammering this week.

Oil.

Oil is in a bear market

The price of oil has been hit hard in recent weeks. At the tail end of last month, Brent crude (the European benchmark) was trading at over $64 per barrel. As of this morning, it's trading at around $57 a barrel. The drop was even harder for WTI, the US benchmark. It's fallen from around $58 a barrel to below $53 this morning.

What's going on? I suppose it's pretty obvious. Recession and slowing growth mean a drop in demand for oil (or at least a drop in the rate of demand growth). If demand weakens more rapidly than supply, then prices fall.

Of course, it's never that simple with oil, because there's a lot of speculation and not entirely reliable data thrown into the mix. Not to mention things like unexpected production cuts, or flaring tension in the Middle East (which never goes away, but matters more some days than others).

But overall, the outlook is not a pretty one for oil producers, it seems. The International Energy Agency (IEA) has just come out with a report that suggests that oil demand growth in the first five months of 2019 was the worst it's seen since the same period in 2008. Now we all know what happened in 2008, so that's not a soothing statistic.

What's it down to? Trade tension and slowing growth. The IEA previously reckoned that oil demand in 2019 would grow by 1.5 million barrels of oil a day. It now reckons growth will come in at just 1.1 million barrels per day. That's nearly a third off and it's still one of the more optimistic views out there.

Meanwhile, supply has more than kept up. Oil cartel Opec has cut production by two million barrels a day over the past year, says the Financial Times. But growth elsewhere mostly from US shale oil is set to almost entirely offset that this year.

As a result, oil is now firmly in a bear market, with Brent down by more than 20% since April, notes the Financial Times.

I hate to say it, but oil could go either way

So what could happen next? The problem with oil right now is that you can make lots of fundamental arguments for big moves in either direction. It's not blatantly cheap or hated as it was back when it dived to $30-odd a barrel in 2016. Yet it's not obviously expensive either.

On the one hand, if we're heading into a recession and a slowdown which seems very possible then oil could go lower from here. China is particularly important. As Gregor Macdonald in The Gregor Letter points out, Chinese vehicle demand has dropped in the first five months of this year, and so has fuel consumption. Meanwhile "US gasoline demand is putting in a third year of no-growth."

There's also the issue of shale production. Opec can cut as much as it wants, but much of the shale production is now in the hands of the oil majors, who have a better ability to sustain losses in shale production because they can offset it elsewhere.

On the other, if we get a surprise on the trade front, or we get central banks loosening monetary policy in a highly aggressive manner (yes, they look as though they're struggling right now, but every single other time investors have thought that since 2008, they've pulled rabbits from hats) then maybe the gloom is overdone.

My colleague Dominic is bullish on oil for the long run. I'm ambivalent, I have to say. I struggle to have a high conviction view on oil here. It has a habit of making big sudden moves which is one very good reason to be circumspect about staking money on what it might do next.

But at the same time, I don't see a compelling reason to ditch your exposure to it (particularly as Dominic's favourite play is BHP Billiton, which also has exposure to lots of other commodities).

I realise that's not very satisfying, but I have to be honest about it. It's one of those ones that could go either way. In the longer run, I think that having more oil in the hands of more reliable trading partners, combined with a rise in electrification, could be an absolutely brilliant boon to the global economy.

But right now, the slide in prices is being driven more by fear of a slowdown so an ongoing collapse would probably be a warning sign. We'll have more on oil in tomorrow's Money Morning where we run through our "charts that matter".

PS If you're in Edinburgh this month (or you're thinking of going), don't miss our show at Adam Smith's former residence, Panmure House. Dominic Frisby, then Merryn Somerset Webb (from 17 August) are hosting panel discussions on the biggest issues of the day with various great minds in attendance (oh and I'll be there on 22nd and 23rd). Get your ticket here now.

Last week's attacks on two tankers in the Persian Gulf are hardly a job for Hercule Poirot, says John Hulsman in City A.M. With Donald Trump's White House applying "maximum pressure" on Iran's economy, Tehran "had the motive, means, and opportunity to perpetrate the crime."

Whoever is responsible, the incident has raised new concerns about global oil supplies. About one-fifth of the world's oil travels through the narrow Strait of Hormuz, where the attacks occurred. The Economist points out that a 2008 study found that if Iran mined the choke point it would take the US "the better part of a month" to reopen the crucial waterway. The burning ships sent Brent crude up by 4%, yet at $61 per barrel the price remains well below the April highs around $75.

Demand trumps supply

Along with slowing demand, the other crucial factor keeping a lid on oil prices is the "abundant supply of US shale oil", write David Sheppard and Harry Dempsey in the Financial Times. US commercial crude-oil stockpiles climbed by another 2.2 million barrels in June.

Swings in the world's most important commodity price have far-reaching economic implications. On one hand, higher energy costs for business are passed onto consumers through price increases, bolstering inflation. Yet on the other, because an oil-price spike operates like a tax increase on many economic activities it can end up choking off demand, which is deflationary. An analysis by Oxford Economics has found that Brent at $100 per barrel would shave 0.6% off global GDP by the end of 2020. The world economy is currently expected to grow by 3.3% this year.

"Every major recession we have seen has been preceded by a ramping up of global commodity prices," Chris Midgley of S&P Global Platts tells The Guardian. Surging crude prices "would raise a huge recessionary risk".

For the time being, it appears that weakening demand and US shale supplies will prevent a runaway bull market in oil. Yet with growth weakening across the world and the trade dispute worsening, talk of war in the Middle East is yet another headache for investors.

Just before I get started this morning, I just wanted to highlight an event taking place later this year that I reckon will interest the vast majority of you on 9 October, in London, MoneyWeek's David Stevenson will be talking to Charlotte Ransom of Netwealth with The Week's Jane Lewis about how to pay for retirement. Book your tickets here now.

Back to today's topic, and oil has had a volatile week.

Brent crude fell hard on Wednesday after US oil stockpiles came in higher than expected.

But then the price jumped again yesterday, after two oil tankers were attacked in the Gulf of Oman.

What's going on? And what does it mean for your portfolio?

What conflict in Iran might mean for your money

Whatever else you want to say about Donald Trump (and I'm not a fan), compared to other US presidents, he's been something of a pacifist. One idea behind "America First" as a policy, is that the US no longer acts as global policeman.

I think it's fair to say that the majority of Trump's core supporters think that America has spent far too much blood and treasure on wars in foreign countries of dubious purpose.

That said, tension with Iran has been a constant during Trump's administration, and it's only getting worse.

Yesterday, two oil tankers one Norwegian, one Japanese were severely damaged by "unknown weapons" (reports the FT) in the Gulf of Oman, which is near the Strait of Hormuz. No one was hurt but the vessels were left drifting.

This matters for the oil price because about a third of all seaborne oil transport goes through the Strait of Hormuz. So if there's the chance that it will be shut down and Iran has a history of threatening to do so then that has a serious impact on oil.

And this isn't the first such incident. Last month, Saudi Arabia complained that a number of ships had been targeted off the coast of the UAE. The US has also sent more military resources to the region.

Iran denies that it is behind the attacks. The US and Saudi Arabia say that it is. You can construct all kinds of conspiracy theories here, which I have no desire to do, but there's little doubt that the Saudis would like the US to put the boot into their number one rival in the region. At the same time, Iran isn't exactly short of trouble makers either.

Now, as I said earlier, Trump's base are not keen to get involved in more wars that they see as none of their business. But there are a lot of "hawks" in his government who have been itching to get a crack at Iran for years. So it's not obvious which way this would go.

I would very much rather avoid any sort of conflict in the region for the obvious reasons. It's an extraordinary waste of life, and the people who start these things are rarely the ones who bear the worst consequences (which is one big reason that they get started in the first place skewed incentives).

Putting all that aside, what does this mean for your portfolio?

In all likelihood? Very little.

Why war rarely has a long-term impact on markets

While conflict draws headlines, markets are historically pretty blas about it. There are short-term reactions certainly. And if specific companies and sectors are directly involved, then yes, of course there's an impact.

But callous as it might sound, investors can mostly ignore geopolitical conflict when it comes to their overall investment strategy.

Indeed, from an investor's point of view, the main impact of any conflict in this region would boil down to whether a higher oil price could have knock-on effects on inflation, and therefore, the willingness of the Federal Reserve America's central bank to cut interest rates at a push.

Markets are currently desperate for the Fed to cut rates. They seem to feel that we're on the verge of collapse unless we see urgent action from Jerome Powell and company.

The good news for markets is that even if the oil price did shoot up, it's unlikely to dissuade the Fed, which has a remarkable ability to ignore inflation of almost all kinds as being temporary. Instead, the Fed's decision will boil down to whether or not Jerome Powell decides to indulge the market or not.

Meanwhile, the International Energy Agency (IEA) pointed out this morning that, in any case, soaring US oil production is offsetting attempts by oil cartel Opec to prop up prices by cutting production.

The IEA reckons that non-Opec supply will grow from 1.9 million barrels a day to 2.3 million next year. This means the world won't need as much from Opec. In fact, it'll need less than Opec is currently pumping.

This of course, is another reason behind all the current tension in the region. The US shale glut is destroying the business model of all of these countries that produce oil but not a lot besides. If you run a dictatorship, and your economy is running into trouble, the first port of call is to find an external enemy to focus civil frustration on.

So all in all, this is concerning incident on humanitarian grounds. But does it make a difference to your portfolio? Most likely not.

The oil price has hit a new high for this year.

Brent crude (the European benchmark) has risen to around $74 a barrel, while WTI (the US equivalent) is around $66.

Why? There's always a story in the oil market. And this week, it's all about Iran.

The latest explanation for the rising oil price

The US had already imposed sanctions on Iran, but until this week, it had granted waivers to allow certain countries to continue to import Iranian oil without fear of American disapproval.

That's no longer the case. The waivers will be removed at the end of the month. After that, countries who continue to import oil from Iran could also face US sanctions.

What kind of effect might that have on the market? Well, during the past five months, notes the FT, Iran has managed to export anything between one million and 1.9 million barrels of oil a day, according to various expert analyses. It's not Saudi levels, but it is significant.

Most of that oil has gone to India, China, South Korea, Japan and Turkey. China is likely to tell the US to sling its hook and carry on importing, and some or all of the others may well think about doing the same, but there's no doubt that this will make it harder for Iran to produce and export its oil.

The US says that it has already got this covered Saudi Arabia and the United Arab Emirates are going to pump more to cover the gap. Given that Saudi Arabia has been holding back on production with the aim of propping up prices, the spare capacity is certainly there.

On the other hand, Iran isn't the only country where supply is under threat. Venezuela is being hit both by sanctions and by economic collapse (the latter predates the former by the way, regardless of what regime shills try to tell you). And you've got Nigeria and Libya, both of which are vulnerable to conflict.

Equally, there's no guarantee that Saudi Arabia will step up. On the one hand, it will relish the chance to poach its arch-rival's customers; on the other hand, keeping oil prices high is very tempting too.

Why Donald Trump won't be happy about rising oil prices

Now, we can see why the US might be keen to keep oil prices down. The average price of petrol in the US is now at its highest since October last year, and as the Financial Times points out, it only needs to rise by another few cents to hit a five-year high. That is not something that Trump will be happy about.

Voters care about the economy. The good news is that, as long as their personal situation seems broadly stable ie, they have jobs and somewhere to live they won't worry too much about the "big picture" anxieties, like the national debt.

However, there are a couple of key measures (which vary from country to country) that as a rule of thumb will worry them. And the bad news as a politician is that you have little direct control over them.

In the UK, the two prices that people care about are house prices and petrol prices. One is a measure of personal wealth and the other is a measure of how much pressure is on your income.

For the US, the wealth measure is different voters care about the level of the S&P 500 rather than house prices. That's because more Americans have money in the stockmarket, or aspire to.

(Incidentally, this is why the central bank and government in the US act to prop up the stockmarket; whereas in the UK, the central bank and the government act to prop up the housing market.)

But as far as income goes, the measure in the US is the same people care about how much it costs to fill up their cars. And in the US, it's a much bigger deal when the oil price rises. That's because tax on petrol in the US is relatively low, so any rise in the oil price results in a much bigger move in the price at the pump.

Given that there's an election coming up in 2020, Trump won't want record high oil prices and therefore high petrol prices rattling the voters. It doesn't help that voters in pro-Trump states tend to spend more of their income on petrol.

Trump can't suppress the oil price and nor can anyone else

But can he do much to prevent this? Absolutely not. Beyond the occasional strategic "release" from America's oil emergency reserves, there's not a lot any president can do to manipulate the oil price.

That said, the ability of oil cartel Opec to fiddle with oil prices is also over-exaggerated. The reality is as I've pointed out before that moves in oil prices are often as much a function of the market's risk appetite as a result of moves in the balance of supply and demand.

Put simply, when the market is in "risk-on" mode (which it clearly is now, what with Larry Fink at BlackRock talking about a pending stockmarket "melt-up"), the oil price tends to go up.

And given that the melt-up probably won't end until it reaches a point where the exuberance exhausts itself (or fear of inflation and rising Federal Reserve interest rates returns), I suspect that the path of least resistance for oil will be higher.

I wouldn't bet on the oil price directly (too many ups and downs; too much hassle). But if you're hanging on to oil producers in the face of all this "sustainable investment" talk, keep hanging in there. They have a while to go before they're obsolete.

And do subscribe to MoneyWeek magazine if you haven't already what with all of this talk of a "melt-up" you might want to have some investment ideas at the ready to take advantage. Get your first six issues free here.

US president Donald Trump isn't keen on higher oil prices.

He wants to be seen to be keeping them down higher oil prices means higher petrol prices (that's "gasoline" for our US readers).

Trouble for Trump is, it'll take more than a few tweets to keep the price of black gold from rising further.

The politicisation of markets

Markets in general are increasingly politicised. By this, I mean that politicians increasingly feel that they have the right to intervene in the price-setting mechanism in an overt manner.

That's what happens when you very visibly step in to save one powerful industry from the consequences of its own mistakes. By bailing out the banks in 2008-2009 and not imposing sufficiently visible penalties for that, the way was paved for the death of the consensus on free markets.

Those rules clearly only applied to the "little people". And now the "little people" want to know why they should abide by those rules if the "big people" don't have to.

Hence you have all this talk of MMT (money-printing for "the people") and calls for the nationalisation or break-up of industries from utilities to technology.

Many (most, even) of the objections are entirely valid. The problem lies with the proposed solutions, which will mostly lead to even more chaos and value destruction.

There's a chap called Ben Hunt who writes very well (and rather prolifically) about this stuff with his colleagues at Epsilon Theory I recommend you check out his website. (But finish reading Money Morning first).

Anyway that's all a tangent to today's main topic, although hopefully an interesting one.

I bring up politics because I want to talk about one of the most politically-sensitive markets in the world the oil market.

If you're a US politician, there are two prices in markets that you keep a close eye on. One is the level of the S&P 500; the other is the price of oil. Here's why.

Americans care about the stockmarket the same way that the British care about the price of their house. If it's going up, they are happy with the economy; they feel wealthier, so whoever is in charge must be competent. So if they're a swing voter, they'll likely go with the incumbent.

For oil, it's the opposite. In Britain, petrol is quite highly taxed and so, while we see the effect of a rise in the price of oil, it's not always glaringly obvious (and the pound/dollar exchange rate has an effect too).

But in the US, gasoline is lightly taxed. So a rise in the price of oil goes almost directly through to the pump price (there's lots of stuff in the middle about refining too, but let's keep it simple for now).

If it cost you $30 to fill your tank last year and it's costing $40 today, you notice that. And you don't feel happy about it whoever is in charge must be an idiot. If share prices are falling too well, it's time to vote for someone else.

It doesn't matter what Trump or Opec say

This is why Trump will be jittery about the oil price climbing to its highest level so far this year. The price of Brent crude jumped above $68 a barrel yesterday.

For today, the market reporters are blaming sanctions on Iran and Venezuela (whose production was collapsing along with its economy in any case). We've also seen production cuts from Saudi Arabia to try to prop up the price from last quarter.

There's also been the worry about the state of the global economy, even although that strikes me as being a fear that was raised in part by the falling oil price (a good example of "reflexivity", where investors assume something about the real world based on changes in market prices, and then behave accordingly, resulting in a self-reinforcing belief).

The question is: how high can prices go, given that you've got the shale producers pumping as fast as they can on the other side of that trade?

As David Sheppard reports in the FT, the US sees its "growing energy bounty as a key foreign policy tool." The fact that the US could be energy independent (if it wanted to be) has also allowed it to use its dominance of the global monetary system (the fact that the US dollar is the reserve currency) as more of a weapon.

(This is not new to Trump as the shale boom accelerated, Obama Barack was quite happy to use the dollar as a weapon too but Trump has certainly embraced the approach).

So if Trump wants to cap oil prices, while Saudi Arabia wants to push them higher, then who wins?

I suspect that question is a red herring.

Trump cannot make shale producers pump more oil than they want to. If shale producers can make a profit, or need the cash flow, they will produce as much as they can, regardless of anything the president says.

As for Opec the Saudis might want to prop up prices, but history shows that their ability to influence the price is, in fact, far lower than your average person believes. The collapse in supply from Venezuela is arguably more of an issue, and even then, it's not the main issue.

What's really likely to drive the oil price is the level of optimism investors feel about global growth. The fear that they exhibited at the end of 2018 has not yet materialised. Meanwhile, you have central banks U-turning across the globe and China deciding that there's been enough financial discipline for now.

That suggests to me that the most likely direction for oil prices in the near future regardless of input from Trump or Opec is higher. You can play that in a number of ways but I wouldn't be desperate to sell my oil companies right now, put it that way.

John's book, The Sceptical Investor, is out now MoneyWeek and Money Morning readers can get 25% off by clicking here.

The oil price (as measured by the Brent crude benchmark) has risen by nearly 25% so far in 2019, well in advance of any developed-world stockmarket, as oil producers slash production in a "shock and awe strategy", said Goldman Sachs analysts. So far oil cartel Opec and the other big producer, Russia, have reduced output from 31.6 million barrels a day in December to 30.8 million in January. Meanwhile, Venezuela, another big producer, is in meltdown.

But the surge may not get a lot higher from here. Output cuts could be offset by rising US shale production. Last year, US oil producers experienced pipeline bottlenecks (with oil supplies outstripping the capacity to get it to market), but those should ease by the end of 2019. US output is already expected to surpass 24 million barrels a day over the next six years, according to Reuters. And there are signs that US output is set to rise further.

The latest rig count from energy services firm Baker Hughes shows that US energy firms have boosted the number of rigs drilling for oil to 857, from fewer than 800 a year ago, notes Henning Gloystein on Reuters.

Markets aren't ready for this surge in production, reckon Commerzbank analysts.US supplies are growing much faster than expected, yet this"is being completely ignored at present". As a result, "we view the current price rise as exaggerated and see growing correction potential".