The big news yesterday was that Iran had struck a deal with the rest of the world over reining in its nuclear adventures.
On Monday morning, the oil price – the Brent crude price, in particular – opened sharply lower than where it had closed on Friday night. Stocks that benefit from lower oil prices, such as airlines, enjoyed a bounce.
Yet by the end of the day, the oil price had rebounded all the way back to where it was before any deal had been mentioned.
So what’s going on? Can we expect lower prices at the pump any time in the near future? Or is this as good as it gets?
The fundamentals are against higher oil prices
We don’t have a particularly ‘high conviction’ view on the oil price here in the MoneyWeek office. You can’t say the oil price is at ridiculous levels – it’s not the first asset you think of when someone mentions the word ‘bubble’.
But by no means can you argue that it is cheap. It’s easy to forget how rapidly we’ve got used to an oil price in the $90 to $100 a barrel region.
However, unless you’re very young indeed, you don’t have to cast your memory that far back to recall when $40 seemed like a potentially world-ending economic scenario.
If push comes to shove, as far as I’m concerned, the fundamentals are against oil. We may not see oil becoming as cheap again as it was a mere 15 years ago. But ever-improving technology means that more and more sources – from tar sands to shale oil – can be accessed profitably at current prices. And the cost of accessing those sources will continue to fall.
Perhaps more importantly, the oil price has been high enough for long enough to drive investment into alternative energy sources. There’s enough hype and excitement around electric cars, natural gas vehicles, and smart grids, to push further development in these areas, even if the oil price were to fall sharply.
You can read a lot more about the ongoing development of the fracking revolution in my colleague Matthew Partridge’s recent MoneyWeek magazine cover story.
There’s also the ever-present threat of more aggressive government rules to combat carbon emissions. Regardless of your views on climate change, this is an issue that you have to take seriously if you’re considering investing in oil.
That’s a pretty formidable array of medium-to-long-term negatives. It does rather beg the question though – why is the price still relatively high?
Politics is keeping the oil price high for the moment
Politics, is the simple answer.
Market reports often talk about ‘geopolitical tension’ as a reason for oil prices fluctuating throughout the day. Much of the time that’s just a way to fill space. Markets move a lot. It’s not always for an obvious reason. And the Middle East has never in my lifetime or most likely yours, been a peaceful region.
But in the past few years there have been more reasons than usual for a ‘political premium’ in the oil price. You’ve had the ‘Arab spring’, the hit to Libyan production, and the fear of revolution affecting a major oil producer, such as Saudi Arabia.
And then there’s Iran. Iran is enriching nuclear fuel. They say it’s so that they can build a nuclear power plant. Everyone else is worried that it’s because they’d like to build a nuclear bomb.
Nuclear bombs are unpleasant things at the best of times. But the idea of a nuclear-armed Iran is particularly unnerving, regardless of your take on Middle Eastern politics.
At the start of last year, war with Iran over the issue seemed a very real possibility. The perception was that Iran had to be stopped before it got the bomb.
But things have calmed down somewhat since. It’s partly because the US has no appetite for another Middle Eastern war, and Israel isn’t keen to act without American backing. It also helps that Iran’s political leadership has changed. Current Iranian president Hassan Rouhani is, if nothing else, a lot less volatile than his predecessor Mahmoud Ahmadinejad.
Now the US has agreed to relax some sanctions, in exchange for Iran agreeing to take it easier on the enrichment front. It’s a tiny step, with a final agreement planned for six months from now. And until then, with many people on both sides sceptical about the deal, it might take time for the consequences to sink in.
However, writes Emad Mostaque of Noah Capital Markets: “What is clear is that the two major powers, Iran and the USA, both want to get this sorted for the first time in quite a while and this bodes well for the future.”
What a lower oil price would mean for your money
So in the longer run, both the fundamentals and the politics seem to be against the oil price going a lot higher. That could all change if the deal falls through of course. But if not, then by the end of next year, the oil price could be a lot lower.
For investors, a slide in the oil price would be good news – in the short term at least. A drop in oil prices is similar to a cut in interest rates. It frees up consumer spending power that would otherwise have gone on necessities.
But ironically enough, a significant slide could lead to interest rates rising earlier than expected. After all, a slide in oil prices would also boost the economic recovery.
In terms of more specific investments, it’s another good reason to focus on companies that have broad exposure to the fracking and natural gas story, rather than the purer oil explorers. My colleague David Stevenson has been writing a lot about the fracking story in his Fleet Street Letter newsletter.
And in MoneyWeek, my colleague Phil Oakley recently dug into oil major Royal Dutch Shell. Although you most probably associate Shell with oil exploration, it has major gas assets too. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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