If you have been paying any attention to the energy markets in recent years, stories of the riches made by other people in the fossil fuel market will irritate you, largely because, like most of us, you would prefer the renewables revolution to be pushing the prices of the likes of thermal coal and oil to nothing, as we smoothly move to net zero.
So the sharp rises in fossil fuel prices – and the implication that there is nothing smooth about the path to net zero – is not welcome.
Oil prices are coming down, but not for long
With that in mind you may have been relieved to see that the world of worry around global recession has finally been slamming commodity prices. Brent crude is 25% or so off its March highs (below $90); US gas prices are down to below $3.90 a gallon from a high of $5; and coal prices are 14% off their highs.
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Unfortunately this is very unlikely to last. You will soon, I think, be irritated all over again.
Look at the dynamics of the oil market. The key point to remember, says Robert Mullin at Marathon Resource Advisors, is that for the past 40 or so years, oil prices have had a pretty firm ceiling and no obvious floor.
When oil prices rose they were met with a combination of new supply from Opec, which never wants the oil price so high that the West invests too much for itself, plus a little from the West, and demand destruction (the cure for high prices was high prices).
That’s just not the case any more. The Opec countries no longer have excess capacity to throw into the mix. At the same time, the “increasingly high share of global energy company capex” diverted to green and carbon capture initiatives in the West, alongside the endless investment disincentives created by the talk of price caps, windfall taxes, export bans and an inconsistent regulatory environment means they have a much firmer floor and a vastly diminished ceiling.
Opec no longer needs to create low prices to dissuade the West from overinvesting – we have banned ourselves from doing it with “fossil fuel shaming”. Opec can now allow prices to stay high with no risk to its long-term revenues. At the same time our collapsed levels of investment have removed any price ceiling.
In the old days if you looked at a chart of oil prices and capital expenditure you would see them pretty much tracking each other. Oil prices up, capital expenditure and future supply up. Look at that same chart today and they do not; even as the oil price has risen sharply since late 2020, capex has fallen.
An opportunity to buy oil stocks at very attractive prices
The cure for high prices is, for now at least, no longer high prices. The story of 2023 will then be one of dual realisation, says Mullin: we will see that we cannot cancel fossil fuels on the timeline our politicians have promised and that “the potential outcomes for crude oil prices have moved up from their historically downward bias to asymmetrically skewed to the upside”. The structural bull case for fossil fuels, driven by climate change policy, remains entirely intact.
Not everyone sees it quite like this. In the medium term, things may shift back to the old normal a little. The new UK government is suddenly mad for fracking and Liz Truss appears to have something of a “drill baby drill” mindset (no bad thing at the moment). But for now at least you may have an opportunity to buy into oil stocks at very attractive prices – something that makes perfect historical sense.
This won’t be the first time a commodity bull market has offered second chances to those who have been a little slow on the uptake. Look back, say the analysts at Schroders, and you will see that corrections of 15%-20% in commodity markets are “completely normal during bull cycles”. There were seven of these in the 1970s and during the commodity bull market of 2001 to 2008 there were five that took prices down more than 10%.
I can’t quite bring myself to suggest you buy stocks that are up 1,000% or more but if you want to buy in there are plenty of good ETFs in the sector. One to look at is the iShares Oil & Gas Exploration and Production UCITS ETF (LSE: SPOG). It’s up 50% year to date, but off a little over the past few days.
• This article was first published in the Financial Times
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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