The great oil price revival will set markets on fire

Photo: Ken Doerr. Cropped. Licence:
Photo: Ken Doerr. Cropped. Licence:

Where the oil prices goes, stock markets follow. The slightest hint of an uptick in demand, a dip in inventory levels or an output freeze, and crude surges and takes share prices with it. When oil soared 12% last Friday on hopes of an Opec production cut, the FTSE 100 duly bounced 3% to end a dismal week on a relative high.

Fun and friendship

So what to make of this morning's news that Saudi Arabia and Russia have agreed to freeze output? Markets are behaving like a spoilt child who expected a bigger birthday present. Over-eager traders convinced themselves that a cut in production was in reach, something that was never going to happen at this point. The oil price is falling accordingly, and share prices are also retreating.

We live in strange times, when pricier oil is seen as good for the stock market and global economy. Cheap crude has traditionally been seen as a positive, because it puts money into Western consumers' pockets and cuts business costs, but not any longer.

The crash has left producer nations nursing ballooning deficits and forced the likes of Nigeria and Angola to run cap-in-hand to the World Bank. Another concern is that stricken US shale companies could trigger a mass bond default that would shake debt markets. Falling demand is also seen as yet another sign that the global economy is running out of steam.

Crude facts

Cheap crude has also been bad news for investors, slashing the share prices of top producers such as BP and Royal Dutch Shell, which are down 27% and 31% over the last year, and explorers such as Premier Oil and Tullow Oil, down 56% and 80%, respectively.

Despite today's deal, oil could still fall further. Markets are oversupplied by a million barrels a day and Iran is set to add another million barrels to that. Saudi still wants to sink the US shale industry and everybody is keen to hang on to market share. Russia knows that slowing the flow of oil will damage its ageing infrastructure and may also require extensive new storage tanks.

Burn baby burn

That said, the kindling for an oil price blaze is gradually being laid. Higher-cost Opec members Venezuela, Mexico, Algeria and Nigeria are postponing projects, investment is down across the board, and shale producers are shaken. Cheaper oil should also fuel demand for gasoline, all of which suggests that crude will catch fire at some point. The Saudi-Russia freeze, if it holds, could pave the way for a future cut.

Phil Flynn, senior energy analyst at The PRICE Futures Group, recently noted that the last time oil suffered back-to-back losing years, in 1997 and 1998, prices more than doubled the following year. If history does repeat itself, oil company stocks and markets will blaze back into life.

And when that happens your portfolio should catch fire as well, assuming you took advantage of low oil and share prices to load up on cheap stocks today.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B and Tullow Oil. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Why Low Oil Prices
Why Low Oil Prices