No Panic Yet For Equity Investors on $100-Plus Oil
Reuters

LONDON - As the oil price floats past $100 a barrel, European equity investors, more preoccupied with the credit market crisis, have yet to press the panic button.

Demand for products from fast-growing emerging markets, a stronger currency and a decline in oil's importance in industrialised economies have combined to mute the impact of the price rise, analysts said.

Oil hit record highs earlier this week when it flirted with $104 a barrel, and is some 4 percent higher this year after rising as much as 57 percent last year. Crude's average price this year is around $94 against $72.30 for the whole of 2007.

This should have caused unbearable pressure on costs for a variety of industries, ranging from chemicals to cement producers, hurting demand and ultimately profits. Worst still, many feared it would be the tipping point that could force cash-strapped households to cut back spending and cause economic activity to slow.

Yet there's been no panic selling of stocks by investors as companies appear to be weathering the oil price rise, in part because of demand from emerging markets, analysts said.

"We've gone past $60, $70 and now $100 a barrel, and demand destruction has been far less than people had expected," said Fortis Bank strategist Philippe Gijsels.

"This could be because demand is much stronger than we think, which shows a decoupling between the United States and the rest of the world," he said.

Companies have also benefited from the fact there has been no supply shock as in the 1970s, when the OPEC cartel used its control over supplies to force up prices.

"Oil prices haven't spiked, and have gone up in linear fashion, allowing corporates to adjust to higher input costs, and we haven't seen the squeeze in profitability seen in previous price surges," said Commerzbank economist Peter Dixon.

"And the sensitivity of GDP in industrialised countries to the oil price is continuing to fall."

Industrialised countries have shifted their emphasis to service-based activities from manufacturing, reducing their dependence on oil.

DOLLAR WEAKNESS

Companies in Europe are also sheltered by the weakening of the dollar, the currency in which oil prices are denominated.

Since the beginning of the year, the dollar has fallen 4 percent against the euro, compensating for the rise in crude.

"The oil price is less of an issue in Europe because of the dollar, but the dollar itself may start to be a problem for the region's exporters," said Gijsels.

"In that sense, a weak dollar and a high oil price together are a nasty combination."

While the United States Federal Reserve has cut rates twice this year and is expected to deliver another reduction on March 18, the European Central Bank has been too worried about inflation to cut borrowing costs.

"Higher crude prices lead to higher inflationary expectations, which tie the hands of the ECB. And if the ECB can't cut, it strengthens the euro further against the dollar, so it's a vicious circle," said Gijsels.

SOME WINNERS SEEN

For four years, stocks and oil rose in tandem as buoyant company profits, strong balance sheets and booming merger and acquisition activity helped investors ignore steadily rising input costs.

Indeed, there was an 87 percent correlation between higher oil and global stock prices between March 2003, the beginning of a stock bull run, and its peak in July 2007.

Analysts even argued that higher oil prices meant that the global economy was strong, which was good for shares.

But this correlation has steadily broken down since the middle of last year, when stocks started to fall due to the credit crisis, and oil went through the roof.

Investors say some sectors will still benefit from oil's surge, and not just oil companies - who are battling high exploration costs - but oil service providers such as drilling companies.

Utility companies that specialise in non-oil power generation are also favoured.

"It's positive for utilities as it gives them the ability to to say to regulators that they have to raise prices due to inflation and they are able to keep cutting other costs," said Canada Life fund manager Mark Bon.

Bon said he was very positive on Danish wind turbine maker Vestas and Germany's SolarWorld, and also liked pollution control firm Twintec, French battery maker Saft, and oil groups Repsol YPF and Total.

He picked French utility EDF for its large nuclear power capacity but said he would avoid French cement maker Lafarge and building materials group St Gobain due to high energy costs.

On the other hand, European airline and leisure stocks, which have been major underperformers over the past year, are likely to take a hit as they struggle to pass on rising fuel costs to passengers.

The DJStoxx European travel and leisure index fell 17 percent last year, compared to a flat broader Stoxx 600.

While there will be gainers and losers with oil at $100, the quest is on to find the next point at which it will all unravel.

"We have reached the point where we can say we can live with $100, the next barrier could be $120," said Bon.

"It's difficult now to disentangle oil from the the other effects on stocks, but oil is very much a risk factor for equities in 2008 - if demand slows due to the credit crisis and margins contract, it will start to matter more," said Commerzbank's Dixon.