A rapid rebound in crude oil prices since last April, the Organization of the Petroleum Exporting Countries (OPEC) cartel’s shifting production plans, Iran’s potential return as a major global supplier—several big oil developments have made headlines recently. That doesn’t surprise us. Events expected to swing oil prices up or down usually spark much attention amongst financial commentators we follow. When prices jump, like they have over the past year, many analysts warn higher energy costs create headwinds for consumers and businesses.[i] In Fisher Investments UK’s view, this is backwards thinking. Our research shows the economy drives oil prices more than oil prices drive the economy.
Oil prices can affect the broader economy. But over the past few decades, economic shifts and huge efficiency gains have muted those impacts. The European economy is far less energy-intensive today than it was during the 1970s energy crisis, when worldwide shortages and soaring oil prices ravaged economies throughout Europe. In 1973, when OPEC declared an oil embargo, heavy industry and construction—energy-intensive areas—comprised 41% of the European economy. Services were 50%, with agriculture accounting for the rest.[ii] By 2019, the latest full-year figures available, heavy industry and construction had fallen to 25% of output, whilst services had soared to 73%.[iii]
In our view, oil doesn’t dictate the economy’s prospects—it is the other way around. Supply and demand drive oil prices, and demand swings with economic shifts. Consider 2020. After ending 2019 at $66.00 per barrel, Brent crude prices plummeted over the next four months, sinking below $10.00 per barrel.[iv] Why? We think the obvious answer is that shutdowns aimed at slowing COVID-19’s spread spurred severe worldwide economic contractions. That kept businesses closed and drivers off roads, drastically slowing oil demand. Falling oil prices didn’t cause the economic contraction—they were a symptom of it.
As the US and European nations began moving toward reopenings that would renew demand, oil prices rebounded. By year end, that and production cuts from OPEC and other major producers that coordinate with the cartel, including Russia, pushed Brent crude to $51.80 a barrel—and it reached pre-pandemic levels by March 2021’s end.[v]
How should investors think about oil, then? Fisher Investments UK thinks it is most helpful to focus on fundamentals—not headlines. Oil’s often-messy geopolitics can create a dramatic backdrop, with regional conflicts, natural disasters and accidents periodically sparking dire warnings that shortages will send prices soaring. Witness the chatter surrounding the container ship Ever Given’s Suez Canal slipup in March, which temporarily blocked oil shipments to Europe.
But for long-term investors, Fisher Investments UK thinks short-term sentiment-driven swings are mere noise. Our research shows supply and demand dictate prices over the longer term. Supply remains plentiful today, with OPEC and its partners unwinding production cutbacks designed to counter supply gluts and industry researchers projecting US production rising in 2021’s second half.[vi] As for demand, industry data show consumption is well off 2020’s lows. But with COVID-driven shutdowns and business restrictions lingering, America’s Energy Information Administration expects it won’t reach pre-pandemic levels until 2022.
Of course, estimates may not match reality. Quicker- or slower-than-expected reopenings could stoke or squash demand—and oil production shifts sometimes involve unpredictable political factors. But Fisher Investments UK thinks a helpful question for equity investors to consider is this: Do you see something others miss about global oil supply and demand drivers—something not yet factored into crude prices? If so, is it likely to impact the global economy in the coming 3–30 months, the period we think equity markets consider? If not, allowing oil prices to impact your equity portfolio decisions is probably not a net benefit, in our view.
We suspect oil price swings will always generate headlines, but remember: Today the economy drives oil prices far more than oil prices drive the economy, in our view. We think investors should keep oil’s impact on equity markets in perspective.
Get exclusive stock market knowledge in your Markets Commentary guide as the first of our ongoing insights.
Follow the latest market news and updates from Fisher Investments UK:
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] Source: FactSet, as of 15/04/2021. Statement is based on Brent crude oil spot prices, which rose from $14.85 per barrel on 31/03/2020 to $63.52 per barrel on 31/03/2021. Depicted in US dollars in keeping with the global standard.
[ii] Source: United Nations Statistics Division, National Accounts Section, as of 14/04/2021. Heavy industry figure includes mining, manufacturing and utilities. Services figure includes wholesale, retail trade, restaurants and hotels; transport, storage and communication; and other activities categories.
[iv] Source: FactSet, as of 14/04/2021. Statement based on Brent crude spot price in US dollars, 31/12/2019–21/04/2020. Depicted in US dollars in keeping with the global standard.
[v] Source: FactSet, as of 14/04/2021. Brent crude oil spot price in US dollars, 31/03/2020–21/04/2020. Depicted in US dollars in keeping with the global standard.
[vi] Source: Energy Information Administration, as of 14/04/2021. Short-Term Energy Outlook, 06/04/2021.