The Saudis have said it could be weeks until production is fully restored, which suggests the spike is unlikely to unwind this month. But an otherwise stable commodity market has suddenly entered unpredictable territory, and over an uncertain timeframe. As such, it’s unwise and impossible to anticipate with any confidence the broader implications for equity markets and asset prices.
Nonetheless, investors should be mindful of several important knock-on effects. The first is what even a single quarter of markedly higher energy prices might do to second-half earnings of corporates for whom oil is a major overhead. Predictably, airlines including easyJet (EZJ) and Ryanair (RYA), as well as mining and manufacturing stocks, fell following the weekend’s news. Hedging can help, but for some big oil consumers sharp price movements can be the difference between a profit and a loss.
The second is the broader effect on the global economy, and the US economy in particular. As we recently noted, discussion of the yield curve’s recent inversion, and its portents for an American recession, have largely failed to mention the cost of energy. That’s probably an error, given that US recessions since the 1970s have followed sharp rises in crude prices. So while we shouldn’t overplay the prospects of inflation just yet, the possibility of rising prices at the pump has suddenly increased, and is far more likely to impact sentiment in the world’s largest consumer economy than the yield on 10-year treasury bonds. Again, a higher risk of recession is bad for stocks.
Third, the prospects for a listing of Saudi Aramco have probably dimmed. For three years, Saudi Crown Prince Mohammed bin Salman has touted the sale of shares as a key plank of his economic diversification strategy. And the longer markets waited for a prospectus to land, the louder the doubters’ voices have become. But in recent weeks, personnel changes in the upper echelons of the Kingdom and reports of investment bank beauty parades have revived expectations that the largest initial public offering in history might indeed take place.
Any pretence that Aramco’s assets are divisible from the Saudi state must now be dropped. So long as oil powers the global economy, there will be some investors keen for exposure to the producer’s cost profile, enormous reserves and generous dividends. But the drone strike underlines a core part of the bear case: that Aramco’s asset base is entirely concentrated in and operated by a state that is currently at war, and becoming increasingly drawn into an unpredictable conflict with Iran.
Finally, the episode is a reminder that in an era of a say-anything statesman and fraying international diplomacy, geopolitics can still provide severe market shocks. Arguably, with respect to oil markets, a degree of complacency had set in. Because while this latest attack is unprecedented in its devastation to short-term production, the mining of Saudi tankers in recent months showed that regional oil production was in play. Prices barely budged, and even dropped last week on the news that Donald Trump had fired national security adviser and renowned Iran hawk John Bolton, implying that oil’s risk premium was thinning.
