Buy oil – we’re going to be reliant on it for a while yet

As the world gets excited about electric cars and hydrogen planes, oil is decidedly out of fashion. But it’s still vital to the global economy, says John Stepek. And it will be for a long time to come.

Oil prices are on a tear – the price of Brent crude is edging closer to the $50 a barrel mark as I write. It might even get there today. That would be its highest level since early March, before lockdown and Covid-19 went global. For a doomed commodity and a “stranded asset”, it’s showing a lot of life.

Oil has spent most of this year in the doldrums. There is no mystery as to why that is: if huge chunks of the world are effectively banned from flying or driving, then you’re not going to need as much oil.

Opec-plus has agreed to pump just a little more oil

On top of that, just as the pandemic was kicking off, Saudi Arabia and Russia – the two biggest producers outside of the US – decided to embark on an oil price war. That, combined with the effect of the pandemic, actually resulted in the oil price (or at least the value of some contracts to take delivery of oil) turning negative at one point earlier in the year.

The Saudis and Russians eventually kissed and made up and announced big production cuts, which helped to arrest the decline, and the price rallied somewhat. However, it’s taken news of the vaccine to push oil back to the point where it might just get back to where it was before coronavirus broke out.

The latest bit of news pushing the price higher came from the latest meeting of the so-called “Opec-plus” oil cartel – which is all the Opec members plus Russia. The group of producers decided that they will pump a bit more oil in January, but not as much as had been expected.

Russia had wanted to pump much more, while the Saudis wanted to maintain the current level of nearly eight million barrels a day of cuts. As a compromise, they’ve decided that output will rise by 500,000 barrels a day in January, rather than the two million a day originally agreed, reports Anjli Raval in the FT.

Anyway, so that’s all helped the oil price. But when you look at it compared to other assets, the rally has in fact been surprisingly tame. Copper, for example, another barometer of global economic health, has had an extraordinarily strong run – going up in pretty much a straight line since the moment of peak pessimism in March (indeed, copper bottomed out literally a couple of days before Britain went into full-blown lockdown). So what’s going on?

Oil versus copper – the past versus the future of energy

There are clearly lots of technical differences between the structure of the copper and oil markets (one’s a lot easier to store than the other for a start). But from a thematic point of view, I think there’s one obvious reason for the gap in relative enthusiasm for each asset: electrification.

Boiling the story down to its simplest form, copper is a play on Tesla taking over the world, while oil is a casualty of Tesla taking over the world. If everything’s going to be electric, you’ll need a lot of copper cable, but you won’t need much petrol. And investors have picked up this theme and run with it. As Bloomberg’s Tracy Alloway noted on Twitter this morning, Barclays has described ESG (environmental, social and governance-related) investing as “too trendy to ignore”, with ESG bond funds attracting far more inflows than their non-ESG-marketed rivals.

Oil producers are lining up, shame-faced, to outline their “pivots” towards “green energy”. Increasingly, fossil fuel reserves are being described as “stranded assets”. Investors are looking to “divest” themselves of exposure to what – by any objective measure – remains one of the most important commodities to maintaining modern existence.

As you might have gathered, I suspect they might be being hasty. I’m not saying that we won’t eventually move into a world lit by wind turbines, and enjoy being ferried about in self-driving cars running on carbon-free hydrogen or sunshine. I would heartily welcome such a world (I hate driving, for one thing). I’m just saying that markets are probably doing what they always do, and getting ahead of themselves. The coronavirus crash won’t be helping that tendency – while investors must realise that the recent oil price crash is about demand collapsing, rather than a sudden transition to a “green” universe, there’s a self-reinforcing element to these things because of the way our brains work.

You see the oil price falling, and you see people talking about fossil fuels being obsolete, you put two and two together, and you come up with fourteen. That’s how markets work. And as a result of all this negativity, you’re seeing supply cut back. If oil companies are focusing on green projects then their oil wells are going to be starved of investment. And if politicians are looking to race ahead in the climate stakes (as is happening right now), then it’ll get harder and more costly to get the oil out of the ground. Denmark has just said that it's going to end all new oil and gas exploration in the North Sea, and that it wants to end “fossil fuel extraction” entirely by 2050, reports the FT.

At some point we’ll be beyond oil (and petroleum). Before that though, the dream of being rid of the stuff is going to collide hard with the reality that we will still need it for a while longer than most investors are currently pricing in. In short, buy oil. Will it be higher a week from now? No idea. But unless you’re day trading the oil price (which is probably not a good idea) then you don’t need to worry about the short-term fluctuations.

Will oil be higher a year from now? Well, I don’t have a crystal ball, but I do have pretty high conviction that it will be. So it still makes sense to invest in oil and related assets, despite the strong rally of the last month or so. Handily enough, last week, Dominic wrote about some of his favoured ways to invest in the oil rally. You can read it again here.

I also covered an interesting way to get exposure to oil in the latest issue of MoneyWeek magazine, out today. If you don’t already subscribe, now’s the ideal time to do it – you won’t want to miss our Christmas double issue, which will be stuffed to the brim with investment tips to take advantage of the recovery in 2021. Get your first six issues free here.

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