Against Oil Odds: Investment Impacts from Plunging Petroleum Prices

The most interesting and exciting thing in world markets this year has been the weakness in the oil price. That has surprised some people, but I do think that it’s important to bear in mind some of the fundamental reasons for it. This video covers some of my thoughts:

  • The weakness is the oil price is the triumph of economists over geologists.
  • For developed-market consumers, lower energy costs are equivalent to a tax reduction.
  • Low energy costs mean inflation will be low.
  • Interest rates could stay lower for longer.

 

 

Video Transcript

The most interesting and exciting thing in world markets this year has been the weakness in the oil price. That has surprised some people, but I do think that it’s important to bear in mind some of the fundamental reasons for it. In a way, I’ve characterized the weakness in the oil price as a triumph of the economists over the geologists. That may sound a bit strange, but what I mean by that is that three…four…five…six years ago, the view from petroleum geologists was that no more oil was being discovered…peak oil…the price would go up inexorably…have to pour money into the business. The economists’ view would be more nuanced about markets. It would be ‘higher prices lead to greater economy in usage and greater conservation.’ They are also a big inducement for the industry to go find new sources of supply.

That’s exactly what’s happened, and the oil price, therefore, finds a much lower clearing rate, which balances that extra supply and lower demand. And I think that structural oversupply in oil has been emerging now for several years. The surprise to me isn’t that the price has gone down so sharply, it’s that it took so long to do it. Because that structural oversupply has been evident and appearing for some time.

In terms of implications, clearly it’s bad for those who have oil wells. But for most of us who don’t, this is actually quite good news. For the developed-country consumer, for example, lower energy costs are equivalent to a tax reduction. And people will tend to spend that; it will be a boost to the developed economies. I do think though that we need to take a longer-term view of this because of the implications that it has for different markets. Lower energy costs mean inflation will be low. That will lead directly to interest rates staying lower for longer than they otherwise would have – that’s a problem for retirement investors. You’re also seeing volatility in equities as energy equities get hit, and also as there are margin calls for oil traders. That’s actually one of the main reasons that falling commodities cause falling equity markets; it’s really a linkage in a very technical sense within the market system.

The implications for asset allocation will be quite profound, and we’ll be working on that over the coming months. But the tax-reduction analogy leads us to be pretty optimistic for developed-world economies for 2015, and maybe into 2016.

There’s also, perhaps fancifully, the thought that this might be the beginning of end of the period when oil dominated world economies. We’re seeing other sources of energy. We’re seeing greater leverage of the amount of oil consumed. This may be, in some ways, the beginning of the end of the Oil Age. That age may end when there’s still plenty of oil in the ground. So we take some positive signs from this and will have to assess the negatives as time goes by. Thank you.

 

 

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