Value Investing

Oil Price is a Distraction for Value Investors

There I said it. The recent plummet in oil price has caught the attention of many. Its precipitous fall has fuelled the negative sentiment in the markets, as oil price is now perceived to reflect the state of the global economy. But I believe, unless you are looking to invest into the oil and gas sector, oil price is a mere distraction. Any obsession over  it cannot be productive.

Oil price is the outcome of two distinct causes

There are two reasons why oil price is at 13-year low, 1) Supply glut as OPEC nations seek to drive out shale producers and 2) Economic weakness in China lowering the demand for oil.

The OPEC factor is a policy decision which is an entirely human-manufactured. It is not based on any fundamental weakness and it happens that its implication is lower oil prices. Unless you are a net importer nation, or an upstream producer of oil, it is hard to imagine why you would fret over cheaper oil. Quite simply, lower prices in an important factor of production such as oil means lower production costs overall.

On the economic situation of China, it is a fundamental weakness. However, lower oil prices are the effect of said weakness, not a cause. Why bother about oil prices then? What you should be looking at is the economic numbers of China.

All in all, the oil prices we see is a function of these two distinct causes which have very different fundamental reasons, even if their effects happen to be the same. Logically, their net effect (oil price) is hardly useful in drawing any insightful conclusion.

Coffee table banter

Oil 1

Looking at how major news publications have been covering oil prices, it is difficult not to be drawn into the cycle of negativity. Remember, they could very well cover the benefits of low oil prices for economies, instead of the doom and gloom that we see today. Remember, journalists are equally susceptible to groupthink and biasedness. And remember, oil price makes for interesting coffee table banter and only that.