Oil prices spiking on potential terror attacks is never positive for equities

Oil prices jumped as high as 4% today after reports of potential surface attacks on two tankers coming out of the Gulf of Oman, next to the Strait of Hormuz, the world’s busiest transit route for oil transportation. It is not entirely clear who was or is behind these attacks, but there are tons of conspiracy theories floating around. To make a call one way or another is way beyond my pay grade. Does anyone feel like they are in a real-life episode of “Designated Survivor” currently?

Let’s stick to facts that are verifiable. History teaches us that oil prices spiking during times of crisis or a geopolitical event is never bullish for Oil Equities or Equities in general. There is no doubt we are living in perilous times and oil traders are nervous. Trader’s knee jerk reaction to buy oil names on the back of a higher oil price can be condoned as naïve as most trading it have probably not been around to see the impact of the 1970’s oil crisis nor the Gulf wars.

Yes, a higher oil price does imply higher oil revenue potential, to put it callously, but if that were to emanate due to a crisis, it usually kills demand afterwards which leads to lower growth and eventually lower earnings. At a time when the world is grappling with slower economic growth (aka serious chances of a recession), this cannot come at a worse time for equities in general nor the Fed which is being coerced by the rates market to cut rates at least three times over the next year. Higher oil prices mixed with lower and falling economic growth makes for a nasty cocktail of stagflation, and bearish for equities.

It will be interesting to see exactly how the Fed navigates cutting interest rates in June or July with markets at close to all-time highs and oil prices holding up here on geopolitical concerns.

Firstly, these tankers were not carrying oil, one was carrying methanol and the other naphtha. As the DOE data reported yesterday, U.S. oil inventories are growing at an alarming pace and remain comfortably above the five-year average. Motor gasoline inventories in the U.S. (driver of peak summer driving seasonal demand) is at the high end of the five-year trading range, whereas Distillate inventories are right in the middle of that range. OPEC and friends have taken about 1.2-1.5 million barrels per day of oil off of the market since December, 2018. To put it bluntly, there is no real shortage of oil. Of course, if the traffic going through the Straits of Hormuz is vulnerable to more attacks, there is a serious risk oil can spike further, but that too is bearish for equities because of the fear of the unknown.

Product demand remains tepid at best and OPEC has downgraded its oil demand growth for 2019. This is a tough time for OPEC which is unsure between raising production now ahead of seasonal demand picking up or keeping cuts in place to avoid prices collapsing and killing their budgets. The OPEC meeting is before the G-20 where President Trump is to meet President Xi to decide whether or not to raise tariffs on the additional $300 billion worth of goods.

Traders are so used to just reacting to knee-jerk headlines, that no one seems to be using any logic whatsoever. They are so focused on not missing out (FOMO) that they will chase any move as long as there is a move. Yesterday we were dealing with Brent breaking $60/bbl. to the downside as demand is weak and supply growing.

Regardless of what happened and why, one thing is clear: equities and oil stocks in general should be weak coming in today, not higher given the spike in oil prices on the back of potential geopolitical threat. The bond market is higher as yields collapse to lower lows and the dollar is rallying. Investors suffering from FOMO should sit this one out rather than be caught long and wrong at the top of the cycle.

Source: The Street