What Investors Can Learn From Oil’s Big Swings
From a rapid rebound in crude prices since last April to OPEC’s shifting production plans, oil developments have been grabbing eyeballs and making headlines. That is no surprise. Events expected to swing oil prices up or down usually spark much attention—and fear. When prices tumble, commentators warn of trouble for America’s increasingly prominent oil industry—and the potential ripple effects to the broader economy. When prices rise, like they have over the past year, they worry higher energy costs create headwinds for consumers and businesses. In Fisher Investments’ view, this is backwards thinking. Today the economy drives oil prices more than oil prices drive the economy—a key investing lesson that oil’s big recent swings support.
Oil prices do affect the broader economy. But over the past few decades, economic shifts and huge efficiency gains have muted those impacts. The US economy is far less energy-intensive today than it was during the 1970s, when an energy crisis led to worldwide shortages and soaring oil prices—ravaging economies. In 1973, when OPEC declared an oil embargo, goods-producing industries—which include more energy-intensive sectors such as mining, construction and manufacturing—composed 31.8% of the US economy. Services were 52.2%. In 2020, goods-producing industries had fallen to 16.9% of output, while services’ share increased to 70.5%. America also does far more with less oil than it used to. In 1990, the US created $13.7 million in inflation-adjusted GDP for every thousand tons of oil it consumed. Today that figure has nearly doubled to $24.6 million.[iv] Oil isn’t the economic swing factor it was decades ago.
Oil doesn’t dictate the economy’s prospects—it is the other way around. Supply and demand drive oil prices, and demand swings with economic shifts. Consider 2020. After ending 2019 at $61.14 per barrel, West Texas Intermediate (WTI) crude prices plummeted over the next four months. Why? Shutdowns aimed at slowing COVID-19’s spread caused severe worldwide economic contractions. COVID restrictions pummeled all types of travel, drastically roiling oil demand. Falling oil prices didn’t cause the contraction—they were a symptom of it.
As the US and other countries began eying reopenings, oil prices rebounded as analysts anticipated some pick-up in demand. By year-end, that and production cuts from OPEC+ pushed WTI to $48.35 a barrel—and it was back around pre-pandemic levels by this past March’s close.
The 2007 – 2009 recession also shows the economy driving oil prices, not the reverse, in Fisher Investments’ view. That economic downturn began in December 2007—yet WTI prices soared 64.0% from December 2007’s start through their July 3, 2008 peak. Only then did prices plunge, falling -79.2% through December 23, 2008 as the financial crisis and worsening recession weighed on demand.
Supply developments don’t drive the economy, either. America’s shale boom more than doubled US crude production from 2010 – 2019, contributing to a global oil supply glut that vastly exceeded demand—squashing prices. The steepest plunge came from mid-2014 to late-2015, when WTI fell from $106.88 to $34.55—a -67.7% tumble. But cheaper oil wasn’t economic rocket fuel, an argument we have seen many commentators make. Yes, real personal consumption expenditures grew by a solid 3.0% and 3.8%, respectively, in 2014 and 2015, but they grew similarly in the mid-2000s—well before America’s oil’s boom (which is incidentally when headlines warned high oil prices would crush consumer spending). In our view, lower oil prices don’t necessarily create new consumption—consumers reallocate their spending from one part of the economy to another.
How should investors think about oil, then? Fisher Investments thinks it best to focus on fundamentals—not headlines. Oil’s often messy geopolitics can create a dramatic backdrop, as regional conflicts, natural disasters and accidents periodically spark big fears that shortages will send prices soaring. Witness the chatter surrounding the container ship Ever Given’s March Suez Canal slip-up, which temporarily blocked oil shipments to Europe.
But for long-term investors, short-term sentiment-driven swings are mere noise. Supply and demand dictate prices over the longer term. Supply remains plentiful today, with OPEC+ unwinding production cutbacks designed to counter supply gluts and US production expected to rise in 2021’s back half. As for demand, consumption is well off 2020’s lows. But with COVID-driven shutdowns and business restrictions lingering, the Energy Information Administration expects it won’t reach pre-pandemic levels until 2022.
Of course, estimates aren’t perfect. Quicker- or slower-than-expected reopenings could stoke or weigh on demand—and oil production shifts sometimes involve unpredictable political factors. But Fisher Investments thinks the question for equity investors is this: Do you see something others miss about global oil supply and demand drivers—something not yet factored into crude prices? If so, is it likely to impact the global economy in the coming 3 – 30 months, the period we think stocks consider? If not, allowing oil prices to impact your equity portfolio decisions is dangerous, in our view.
Oil price swings will always generate headlines. But remember: Today the economy drives oil prices far more than oil prices drive the economy, in our view, an important perspective to keep in mind when considering oil’s impact on the market cycle.
Source: Fisher Investments