Crude Awakening

The price of North Sea oil just hit a two-year high...

The MARKET has a marvellous sense of comic timing, writes John Stepek, editor of MoneyWeek magazine.

In the last few weeks, the papers have been full of talk about how Norway's sovereign wealth fund is looking at extricating itself from the oil sector.

Now if you ask me, that's sensible. Your entire economy runs on oil. Why stick your savings into that mix as well? But of course, the angle in the papers has been:

"Is this a sign that the fossil fuel era is over?"

Divestment, electric cars, lithium, renewable energy – it's all the rage.

Which, of course, makes this the ideal time for the price of oil to rocket.

The latest spike in the oil price was the result of the UK's key North Sea pipeline system, the Forties Pipeline System, being shut down for emergency repairs by privately-owned chemicals giant Ineos (its new owner).

The system "delivers almost 40% of UK North Sea oil and gas production", notes the FT. So it's probably not the ideal time to have it offline, what with the bitterly cold winter conditions now setting in. And it's due to be down for several weeks.

The price of Brent crude oil jumped to a two-year high of nearly $65 a barrel. And the effect on the wholesale gas price was far more drastic – it shot up by nearly 30%.

Now clearly, this is partly a local story. The gap between Brent and WTI surged – in other words, US oil didn't rise in price by as much. But it did rise.

And the interesting thing is that this wasn't really supposed to happen. US shale oil was meant to be keeping a lid on things. And certainly, US production has gone up rapidly this year, jumping by more than 25%.

But what if that's not going to continue? What if companies that skirted bankruptcy decide that they now only pump as much as the market will bear? That the marginal stuff is best left for higher prices? That they'd rather pay down their debts and enjoy a bit of breathing space?

What if they need prices to be a good bit higher than they are today before they even think of re-opening the floodgates?

As Reuters reports, US shale producers were very pleased by Opec's recent decision to extend its production cuts to the end of 2018. At the end of the day, they're all on the same side in some ways. If the shale giants could legally join Opec, you can bet they'd find a way to do it.

And the chairman of one of the biggest shale producers argued that "extra cash from higher prices should go to shareholders, not fresh drilling", lest there be "another price collapse by the end of 2018."

Dividends, not drilling. It seems the shale industry is maturing from a high-tech boom business where capital goes to die, into one where the incumbents circle the wagons, demand tougher regulations, and look to turn their treasure horde into proper profits.

That's an interesting idea. And quite an appealing one for investors, I should imagine.

In any case, this all comes at a good time for investors who like bargains. I mean, in this market, the idea of a bargain is highly relative – Royal Dutch Shell is trading near an all-time high, for example.

But compared to valuations pretty much everywhere else, the energy sector remains fairly inexpensive. As Jim Paulsen of Leuthold Group notes in the FT, "the sector is widely under-owned and represents a contrarian play with a positive potential catalyst from higher oil prices."

We look at some promising oil plays in Latin America in the latest issue of MoneyWeek.