The recent rise in oil prices and its role as a driver of inflation could make exposure to the sector a good diversifier for multi-asset portfolios, according to Miton’s David Jane.
Oil prices have slumped in recent years as slow global growth and the advent of shale oil technology contributed to a production surplus.
Lower prices had a number of effects, as new oil projects dwindled and companies in the sector restructured balance sheets to head off the impact of reduced revenues.
However, prices have risen by more than 10 per cent so far this year with levels reaching around $75 per barrel more recently.
The uptick in prices has been prompted by calls from Saudi Arabia – one of the largest oil producers in the world – for prices to return to $100 per barrel.
Performance of indices YTD
Source: FE Analytics
Indeed, Miton’s Jane (pictured) said while many commentators had believed oil was range-bound, recent developments have proved otherwise. 
According to Jane, a convergence of interests between Russia – another major producer – and Saudi Arabia has coincided with lower-than-expected shale oil capacity, sending oil prices upwards.
As such, the multi-asset manager said the Miton team has been adding exposure to the sector in recent months, noting the role it plays in the economy.
“Oil is in fact a major driver of inflation and long-term inflation expectations, as it remains, for now, one of the world’s most important energy sources,” he said.
“So, higher oil prices have been a significant driver of the recent increase in inflation and inflation is a major driver of asset prices, particularly in bond markets.”
The Miton manager said the prospects for oil were, therefore, “what really matters” although he remains wary of forecasting where prices might go in the future.
“Oil is not a normal commodity in that it operates less in a free market and more in a geopolitically charged cartel,” he said.
“While the non-OPEC [Organisation of Petroleum Exporting Countries] supply and demand can be said to operate on free market principles, the price of oil is ultimately driven by the actions and intentions of a small number of politically-driven individuals.”
Source: OPEC
Under the influence of ambitious crown prince Mohammed bin Salman, Saudi Arabia requires higher prices both to fund its modernising Vision 2030 programme and to support its increased role in the region.
Jane said other OPEC players and US shale resources do not have the spare capacity to confront Saudi Arabia. He also noted that as a key ally of the US in the Middle East, strong oil prices were needed to prevent the collapse of the ruling House of Saud regime.
“Such a collapse would ultimately disrupt production and lead to higher oil prices,” he said. “The alternative of domestic austerity to repair the finances are clearly even more unpalatable.”
As such, Jane said the oil sector “appears to be a good diversifier and ultimately quite defensive as it benefits from many factors such as inflation and instability which are otherwise negative for equities and bonds”.
Indeed, the largest equity positions in the fund, according to its latest factsheet, are Shell and BP, which represent 1.1 per cent and 1 per cent of the portfolio respectively.
The view of higher oil prices has been supported by other fund managers, such as Ashburton Investments’ Richard Robinson who forecasted higher prices driven by several different factors.
The Ashburton Global Energy fund manager said oil companies currently offered good value having restructured balance sheets since the collapse in prices.
While the Bloomberg Brent Crude Sub index rose by 14.25 per cent – in US dollar terms – during 2017, the MSCI World Energy index fell by 1.64 per cent, as the below chart shows.
Performance of indices in 2017
Source: FE Analytics
“The energy sector had a torrid time in 2017, despite a strong oil price,” said Robinson.
“The last time we saw such a wide divergence between oil price performance and equity performance was 2002, the following year was the start of the five-year energy sector bull run, when energy stocks outperformed the S&P by 180 per cent.”
However, some have warned that while Saudi authorities might want oil prices to reach $100 per barrel, they may not stay there for very long if they do.
Andrew Kenningham, chief global economist at consultancy Capital Economics, warned that the recent rise in oil prices could be reversed as it had been driven by concerns over supply rather than any increase in demand.
Kenningham said its forecast was for Brent to fall from current levels to around $55 per barrel by the end of 2019.
“Higher prices should lead to a further increase in drilling activity in the US, which should exert more downward pressure on prices,” he explained.
The economist said if oil prices were to rise to $100 per barrel, the impact on the global economy would be mixed. Rising inflation would have a small negative effect on household consumption and potentially lead to weaker growth in Europe.
However, in the US any negative impact would be offset by greater investment in the shale oil industry, he said.