Publications

- December 1, 2018: Vol. 5, Number 11

Over a barrel: Should investors fear $100 oil?

by Kevin Rosenbaum

Although crude oil prices above $100 a barrel will pinch consumer pockets, investor anxiety on this topic is both premature and exaggerated.

To be sure, the rally in oil prices has been impressive. Since the bottom of the energy commodity downturn in first quarter 2016, the cost of Brent crude has tripled to $84 a barrel. This rise came as producers curtailed investment in new wells to a greater extent than ever before and as global demand grew at an above-average pace. In recent weeks, prices have reacted to data indicating Iranian exports have dropped more than expected, due to buyers looking to comply with U.S. sanctions. This, in combination with concerns about Venezuela’s plummeting oil production, has led to renewed speculation on whether other OPEC member countries and Russia could easily offset a global shortfall.

Still, fearing a $100 barrel is premature. Crossing that threshold this quarter would imply at least a 21 percent jump in Brent crude prices. A quarterly increase of that magnitude for oil is rare, occurring just 15 times in the 30 years of existing data. And, of those 15, only a few followed periods of strong performance similar to what markets have experienced recently. Beyond the historical record, the U.S. government forecasts that global supply will outstrip demand next year, adding to existing oil inventories and putting downward pressure on prices. Indeed, no bank or research house is currently forecasting $100 oil this year or next, at least according to forecasts available on Bloomberg.

Of course, what are forecasts for if not to be wrong? Assuming oil prices climb to $100 a barrel, a greater share of household income would be needed to buy the same amount of petroleum products, all else equal. Businesses, too, would be impacted, not least because transportation costs would rise. But the hit to growth is not what TV pundits frequently suggest. In the history of Brent crude, there are only 19 quarters when inflation-adjusted prices averaged above $100 a barrel. During those quarters, global GDP grew at an average annual pace of 2.6 percent. This is a respectable result, considering global GDP has grown only at a 3.0 percent clip when prices averaged below $100.

All this is not to say that investors should welcome $100 oil. To the contrary, a high oil price will no doubt be more of a drag on global growth and asset performance than a low oil price, all else equal. Yet, markets are rarely responsive to changes in just one variable. Instead, markets reflect the health of a multitude of variables, whose interdependence varies through time. When high oil prices occur alongside other prominent warning signs, then investors should pay close attention.

 

Kevin Rosenbaum is a deputy head of capital markets research at Cambridge Associates. The original and complete version of this article was published on the Cambridge website and can be read at this link: https://bit.ly/2QsqGIP

 

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