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.
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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.
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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.
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