Why Stock Investors Should be Rooting for Higher Oil Prices

After OPEC+ cut oil output last week, forcing crude prices higher again after a sustained move lower from their June highs, most U.S. stock investors were probably mad given that oil prices are so tied to inflation. Then over the last week, when crude pulled back again, suggesting that the Saudi led cartel may not get the higher prices they desire, most probably cheered. However, for the stock market it is no longer as simple as “high oil bad, low oil good,” and from the perspective of our stock portfolios, we should probably be rooting for crude to move higher.

Understand that I am talking here purely from that perspective. There are reasons to root for the exact opposite: Nobody wants more money pouring into Russian coffers to support their war in Ukraine and there are a lot of people who find the Saudi regime distasteful in many ways and don’t want their ruling royal family getting even richer. But if you strip all that away and are looking purely at oil prices as an indicator of what is to come in other markets, lower oil right now would be bad news.

A few months ago, oil prices were all about supply. The post-pandemic supply chain issues that we heard so much about were still around, forcing crude well above $100 in two separate spikes, one in March and the other in June. Economies had bounced back strongly, but oil supply was restricted, both by those generalized supply chain issues and by a White House that viewed increased U.S. oil output as a bad thing. Again, I should point out that I am not commenting on the politics here. You are entitled to view U.S. oil exploration and production as a good thing for energy independence, jobs, or on the other hand, as simply prolonging the problem of American oil dependency while destroying the environment.

What matters from this particular perspective in terms of price is not what you think should happen, just what is happening. The fact is that U.S. supply was politically restricted.

We had a situation where oil demand was increasing but supply was static at best, and you don’t have to be an economics professor to know that less supply and more demand equals higher prices. The supply situation hasn’t changed since June, when oil changed direction. In fact, if anything, the anticipation and the actuality of the OPEC+ move created an even tighter supply picture. It is the outlook for demand that has altered. As central banks around the world have done an abrupt U-turn and started to fight inflation, the prospect of recession has become the number one concern for oil traders.

That is what has led to oil trading lower over the last four months. It is such a worry that last week, even after OPEC+ took 2 million barrels a day of production off the market, WTI futures gave back most of the gains that followed the news. Cutting 2 million barrels of output doesn’t result in higher prices if demand falls by more than that, and that would definitely happen should the world plummet into recession. While lower oil is good for drivers of conventional gas vehicles and gives us all more money in our pockets if energy prices fall, those potential benefits are more than offset by what a move like that tells us about what some very smart people think is coming.

Stock investors would therefore do well over the next few weeks to keep an eye on crude oil, with the understanding that what is a good sign for their portfolio has completely changed. Lower prices are no longer a positive. They indicate a belief that the world is heading for economic trouble that no amount of supply manipulation can overcome so, as weird as it seems after years of doing the opposite, they should be rooting for oil to hold above $80 and even nudge back up towards $100 a barrel. 

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.