On the back of a better than expected DOE inventory report, strong refinery demand commentary and rising tensions in Ukraine, Brent crude oil prices are back at $90 (NYSEARCA:USO). It’s been seven years since seaborne oil prices held this level. In that time oil-linked equities (NYSEARCA:XLE) have fallen ~25%, even as broader equity indices (NYSEARCA:SPY) have risen ~125%. The path forward for oil and oil equities likely rests on a few key factors:
- Demand growth – many market commentators mistook the fall in oil demand during Covid as evidence of a secular decline; with Saudi Aramco (ARMCO) indicating this week that demand is back to pre-pandemic levels, and with the world yet to fully reopened to international travel, it appears demand growth is likely to continue over the medium term.
- Supply growth – following two OPEC-led oil price wars in the past seven years, a consensus is building around OPEC+ being unable to meet its self-imposed production quotas; the market’s focus is now shifting to the shale patch, where producers like Pioneer (NYSE:PXD) and Apache (NASDAQ:APA) are refocusing on shareholder returns, while names like EOG (NYSE:EOG) and Hess (NYSE:HES) are raising capex to accelerate production growth; time will tell whether shale production growth will continue to undermine global prices.
- Price elasticity – as prices rise, consumers consume less; what price, and how much less remain unclear – Goldman, BofA and Morgan Stanley are all assuming that consumer demand for oil products will fall as oil prices rise above $100 later this year, whether or not that assumption proves correct remains to be seen.
As crude retakes $90, energy companies in aggregate are better positioned now than they were seven years ago. Capital spending is much lower, balance sheets are better, in the case of majors like Chevron (NYSE:CVX) and Exxon (NYSE:XOM) share counts are lower, and shareholder returns are higher. Begging the question, if oil is back and oil businesses are better positioned, why the 125% underperformance? The strategy team at Goldman Sachs thinks the underperformance is unwarranted and upgraded the entire sector to overweight yesterday after the close.