There’s an old joke that the Saudis have a lot of money not because of oil, but because they don’t let their wives spend it. With oil prices hitting 2023 highs this week, saying “no” is bound to get harder, even if Saudi oil revenue in the first half is down a quarter from last year.
Long-term production cuts by Saudi Arabia and Russia are said to be to blame for the recent price surge. The two countries supply about 40% of the world’s oil and have expensive football players and drones to buy.
Cue the usual concerns about growth and inflation. Financial markets are in turmoil. Should they be? This column always seems to be covering the news that everyone is panicking about and saying it’s okay. Maybe I spent too much time at the beach.
But once again the popular claims are not supported by the data. To be sure, rising oil prices will hurt economic growth. The cost of producing goods and services rises. Wealth is transferred from many consumers to a few producers.
There are numerous studies confirming this.International Energy Agency’s Rule of thumb An increase of $10 per barrel of oil means a 0.5% decrease in global production the following year. The International Monetary Fund calculated that even a change of $5 would have an impact.
The impact of oil prices on asset values is much more complex. Take bonds for example. You might take it for granted that higher energy costs mean higher inflation means higher interest rates, and that’s a given – which is bad for fixed income securities.
This is sometimes true, as recent papers The University of Pretoria looked at 161 years of US data. The problem, in statistician terms, is that causation goes both ways and changes over time. In other words, when oil prices rise, bonds may rise or fall.
Since World War I, the correlation has been mostly negative (i.e. oil goes up, bonds go down), but not always. It depends on which period you look at. There is no reason why relations between the two countries cannot improve again. Very helpful.
How to explain bidirectionality? This does make sense. The above causal relationship is obvious. But we also know that rising oil prices can have a negative impact on the economy, which could lead to demand for bonds because they are safe-haven assets.
Meanwhile, research on stock returns is even more confusing. Again, this seems counterintuitive. For example, rising energy costs will certainly lead to lower margins and free cash flow going forward. Discounting them means lower valuations.
For some sectors, yes, causation can be shown. 2015 Paper Bing Xu’s research on UK industry shows that oil prices have strong predictive power for energy stocks (positive) as well as industries that use oil as a major input, such as consumer goods (negative).
Well, duh. However, at an aggregate level – the impact of oil prices on overall stock indexes – academics don’t yet have any clues. Or rather, there are so many different threads. Some papers found no relationship, while others found a strong relationship.
A Japanese Studies The correlation is found to be negative (oil goes up, stocks go down).In other markets, e.g. Norway, it is positive. It’s not just the composition of the index that explains the mixed results. The big problem is that oil prices move for a variety of reasons.
If they’re rising because of a booming global economy, then higher input costs should be offset by stronger revenue growth (as I’ve written before on interest rates). In fact, even Japanese stocks like rising oil prices at a time when demand for all commodities is surging.
But when oil alone experiences a demand shock, the picture is different—perhaps buyers are buying ahead of schedule out of concern about future production. In these cases, the relationship becomes negative again.
Here, you might expect supply shocks – even minor surprises like we’re seeing now – to be equally negative for stocks. If producers simply reduce production, prices will rise if demand is strong.
Again, data doesn’t work.Research by economists et al. Lutz Kilian and Tiefan Park One suggests that the supply side is less important than global demand shocks or even industry-specific movements in oil prices.
So this isn’t quite the simple oil story that the headlines suggest. In fact, it’s even more difficult for investors. This is because it is not enough to establish that there is a causal relationship between two variables. It is important to predict in advance that one of these will change.
No one is more likely to make mistakes than oil analysts. By far the most embarrassing calls I’ve heard in my years working in the financial world have been predictions about the price of Brent crude oil or West Texas Intermediate crude oil. This is unfortunate given how important oil is to human livelihoods, if not always to markets.
So much so that in 2011, the Federal Reserve commissioned international discussion paper The title should be: “How the fuck can we accurately predict the price of oil?” One of the answers, according to the test of causality, is to track U.S. inflation. Therefore, the money supply is measured too narrowly.
But interest rate and currency movements have no predictive power, according to Fed data analysts. Changes in real GDP also do not predict changes in real oil prices. What’s more, given how many central banks rely on futures prices, futures prices are no more prescient than spot prices. In fact, between one and three months, it’s “worse than flipping a coin.”
All of which means investors don’t have to worry about $100 oil prices. Likewise, $50 is the IEA’s latest forecast that demand for fossil fuels, including oil, will peak before the end of the decade. Still, everyone tells us we should.
Oil prices are at 2023 highs, but so is my portfolio.
The author is a former portfolio manager. e-mail: Stuart.kirk@ft.com;X： @stewartkirk__
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