Why an oil price spike shouldn’t spook equity investors
The recent drone strike in Saudi Arabia sent shockwaves through the oil market. However, as Tim Bennett explains, equity investors should remain calm.
Why an oil price strike shouldn’t spook equity investors
Newsworthy events can cause big ripples in specific markets. However, equity investors are usually best advised not to react in the short-term. Here’s why.
Oil markets were sent into something of a tailspin when news broke that drones had successfully attacked a major oil facility in Saudi Arabia over the weekend. On Monday morning, when markets opened, the oil priced duly leapt 20% in its biggest one-day gain since the invasion of Kuwait in 1990. The question is what, if anything, equity investors should do when such events occur. The best answer if often, “little or nothing”.
The reasons why are what I want to explore briefly here. They can be summed up as follows;
Let’s look at these points in a bit more detail, starting with global oil stocks.
Whilst this strike in Saudi was a huge event – some estimates put the potential loss of global production in the short-term as high as 5% – even the oil market reaction to it was not as extreme as some initially feared. Both the IEA and UDDE report high levels of strategic reserves, which may help to explain why the oil prices settled back quickly to more like a 15% rise on Monday and well below either it’s level a year ago, or its recent peak back in 2014, let alone its all-time high.
Although it is still a vital commodity globally, as the next chart shows, the world is working hard to reduce its dependency on oil, whether through developing new sources (such as Shale oil) or via substitution with renewable energy. As a result, oil is now much less important to electricity generation in the West, for example, than it used to be, even if it retains a key role in many industrial and transportation applications. It is also still in high and growing demand in emerging markets.
One good reason why equity investors might react to an oil shock is if it added significantly to inflation (via rising petrol prices and utility costs) and could therefore trigger a rise in interest rates or a reduction in other stimulus measures such as quantitative easing. But whilst this event is likely to have some impact on inflation, it may be relatively short-lived and, besides, consumers in the West are well-placed to absorb it at the moment thanks to rising wages.
Winners and losers
The final point to bear in mind is that there are winners, as well as losers, from a price spike like this. And some of those winners are huge – think oil giants BP and Shell. So, whilst airlines stocks, for example, were marked down in the wake of this strike, oil related stocks enjoyed gains. Overall therefore stock markets (other than, of course, the local regional ones) didn’t record a big reaction.
In summary then, for equity investors this sort of event is another lesson in not paying too much attention to the headlines and not trying to second-guess how stock markets will react.