Will Stocks Slip on Higher Oil Prices?

Are oil prices headed back to triple digits? Some commentators in financial publications we follow say so after two major producers, Saudi Arabia and Russia, extended supply cuts last week. But in our view, overlooked drivers imply oil prices will be range-bound—so the presumption the recent rise in crude means much higher levels and fuel prices ahead is likely off base.

Oil prices climbed throughout the summer, from $74.51 per barrel at June’s end to $90.67 a barrel on 11 September, an increase of more than 21%.^[i] That has led to higher fuel costs, including for petrol and diesel—and the latter has been getting attention in financial commentary we monitor due to its myriad uses, including commercial transport and manufacturing.^[ii] Now, with Saudi Arabia and Russia extending their voluntary production cuts of a combined 1.3 million barrels per day (bpd) from June levels through yearend, we have observed many questioning the implications.^[iii] Will oil’s rise hurt consumption? Does more costly crude spell trouble for already flagging demand and economic activity in China? Will it reignite inflation (broadly rising prices across the economy)? Is this a sign to buy Energy stocks, since we find their earnings are price-sensitive?

But our review of recent history suggests the moves of Saudi Arabia, Russia and its partners within and outside the Organization of the Petroleum Exporting Countries (a group collectively known as OPEC+) aren’t major swing factors for oil markets. Last October, OPEC+ announced voluntary cuts to reduce production targets by 2 million bpd (from August 2022 levels)—to about 41.9 million bpd—starting in November and lasting through 2023.^[iv] The cartel followed that with another “voluntary production adjustment” in April this year amounting to 1.66 million bpd.^[v] Despite all the speculation, we doubted OPEC+’s decisions would send oil prices soaring. Based on our observations, OPEC+ members have struggled to meet their production quotas for myriad reasons, including disruptions (e.g., worker strikes in Nigeria) and underinvestment.^[vi] Given most of the cartel’s members are already undershooting their production quotas, Saudi Arabia and Russia have seemingly taken it upon themselves to support oil prices with additional voluntary summertime production cuts.^[vii]

These announcements seemed to spur some short-term volatility at times—as is often the case with OPEC+ news based on our monitoring of financial headlines—but taking the longer view, we haven’t seen the cartel’s lowering targets and production cuts lead to prices climbing back to early-2022 levels. Rather, Brent crude prices have mostly bounced sideways. (Exhibit 1)

Exhibit 1: Oil Prices Amidst Select OPEC+ Announcements

Source: FactSet, as of 11/9/2023. Crude Oil Brent Global Spot price in USD, 30/6/2022 – 8/9/2023.

OPEC+ cuts often receive attention on the supply front in financial publications we follow, but we think the effect is limited since non-OPEC+ producers can offset those reductions to a great extent. The world’s largest single-nation producer, America, is set to hit an output record of 12.8 million bpd this year.^[viii] Canadian production has ramped up over the past couple years, and analysts we follow estimate Canada will add almost 8% to its total output over the next two years.^[ix] Brazil’s oil and gas production hit a record high in July, and its main oil producer has increased investment in exploration and production.^[x] It may not be a one-for-one exchange, but roughly speaking, non-OPEC+ producers—who adhere to market forces rather than a cartel’s mandates based on our research—can step in and supply oil if prices make it worth their effort.

Meanwhile, despite fears of weakness from China, oil demand is showing few signs of abating—the IEA reported world demand hit a record in June and is set to register its highest annual level this year.^[xi] In our opinion, persistent demand amidst resilient supply argues against prices soaring far higher or sinking vastly lower from here (volatility notwithstanding). Note, too, the summertime uptick isn’t so worrisome when compared to even just last year—oil prices are far off last March’s high. (Exhibit 2)

Exhibit 2: A Longer Look at Oil Prices

Source: FactSet, as of 11/9/2023. Crude Oil Brent Global Spot price in USD, 31/12/2007 – 8/9/2023.

Higher oil prices can feed into many popular concerns in financial headlines today, but our studies of market history have found they don’t signal trouble for stocks or the economy more broadly. As the aforementioned Exhibit 2 shows, oil prices were in the triple digits for much of the early 2010s—a stretch when major economies including the UK and America were expanding and global stocks were just a few years into a decade-long uptrend.^[xii] Now, oil supply shocks can stir uncertainty—but that looks unlikely at this point, in our view. We don’t think even an upward drift in prices, which isn’t a given, is a major negative for stocks now.