The oil price would remain high even if the war in Ukraine ended tomorrow, according to Jupiter’s Richard Buxton, who blamed environmental, social and governance (ESG) pressure for disrupting the supply/demand balance that keeps commodity valuations at a reasonable level.
Brent crude exceeded $130 (£106) a barrel on 8 March, a matter of weeks after Russia’s invasion of Ukraine. However, it had been approaching $100 a barrel even before the war, on a surge in demand following the post-Covid re-opening of the global economy.
Performance of index over 3yrs
Source: FE Analytics
And Buxton, who manages the £705m Jupiter UK Alpha fund, said the failure to keep up with demand will be what keeps oil prices at an elevated level for the foreseeable future.
“In the good old days, the cure for high commodity prices was high prices, because they would attract more capital and people would drill more or sew more and you would increase supply,” he explained.
“And equally, the cure for low prices was low prices, as capital would withdraw and ultimately there would be less supply and prices would rise.”
However, he said that the rise of ESG investing and the push for net-zero carbon has broken the relationship between the flow of capital and returns. The oil & gas majors have responded to pressure from governments, regulators and fund managers by cutting back investment in fossil fuel assets, but this has meant there is no supply response when an event such as the war in Ukraine hits markets.
“The EU has moved swiftly and said, ‘we've got to wean ourselves off Russian gas, so we must start investing in more LNG [liquefied natural gas] terminals and things like that,” Buxton continued.
“That’s absolutely terrific. But the fastest new LNG terminal built in the US took two years and that was adjacent to an existing one. Even for floating gas terminals, you're probably looking at 2024 to 2026 before they come on stream.”
He added: “Then you’ve got to build massive pipelines. So if the Ukraine war stopped tomorrow, oil prices would fall, but I fear we're still going to be in a situation where $80 to $120 a barrel is not unrealistic.”
Other fund managers disputed Buxton’s view. Craig Bonthron, manager of the Artemis Positive Future fund, said that while it was easy to blame ESG investing for the high oil price, in reality it was down to simple economics.
He pointed out the combination of the commodities boom between 2000 and 2010 and the subsequent US shale-oil boom resulted in significant over-investment. This meant the market became oversupplied with oil & gas, leading to a down cycle in capital expenditure.
Performance of index over 20yrs
Source: FE Analytics
“What external pressure there has been on oil companies to reduce investment in new fields fitted neatly with the desire of their boards to rebuild their balance sheets and generate cash,” he explained.
“The simple fact is that most new oil & gas projects take up to 10 years to come online – and energy prices over the past few years have been too low to justify investing in new fields.”
Instead, he blamed the energy shock on relying on a source of fuel whose supply was controlled by a cartel of “largely undemocratic regimes, as should be evident from recent write-downs (and climb-downs), as many of the biggest oil companies were highly exposed to the Putin regime”.
Whatever the reason for the spike in the oil price and the impact on the cost of living, Buxton said the market has reacted by shaving a minimum of 25% off all cyclical stocks over the past few weeks. On the plus side, he pointed out the bad news was already priced in, and the market may be discounting an overly pessimistic scenario.
“Outside of US housing, there are actually very few signs as yet of any economic slowdown,” he said.
“We've had a raft of first-quarter trading statements and it’s not that bad. There are a lot of questions on the ability of companies to recover rising input costs, and at the moment, most companies are able to maintain margins to a considerable extent through price rises.
He added: “So there’s a very mixed picture in terms of the market expecting things to get worse, but as yet there is not much evidence that they are.”