Market Musings 200622: Oil & Gas correction: opportunity or trap

20th Jun '22 by Edmund Shing

12 comments 2206 reads

Market Musings 200622:
Oil & Gas correction: opportunity or trap

Should we be buying this pullback in oil & gas stocks, or have they seen the top?

Summary:

Global oil demand has not yet really fallen
Recession fears drives oil prices only down to $110/barrel
But the oil & gas sector has fallen 12-20% in 2 weeks
This looks more an opportunity than a risk for oil & gas stock investors
Idea of the week: Solar Energy ETFs, Infrastructure funds

Global oil demand has not been all that affected by the high price

Global demand for crude oil, refined oil products and natural gas have not fallen much despite the huge move up in prices.

Despite the best efforts of President Biden with his use of the US Strategic Petroleum Reserve (SPR) to relieve oil shortages and lower prices, crude oil prices remain around $110/barrel and US retail gasoline prices have breached new highs at > $5/gallon (= 3.8 litres).

However, much of the increase in the crude oil price has happened with oil for immediate or near-immediate delivery, with a much smaller increase in futures prices for delivery in a few years’ time.

In the chart below, the orange spots are the crude oil futures prices for delivery at different months as of today, while the green spots are where these futures prices were at the beginning of 2022.

Brent crude oil for delivery in August 2022 is priced at $112/barrel today, up $37 from its end-2021 level.

In contrast, crude oil for delivery in August 2026 (4 years from now) has only risen $13 over this same period, from $64/barrel to $77/barrel today.

Brent crude spot price gas risen a lot more than long-term futures prices

Source:Bloomberg

This is important because oil companies tend to base their investment decisions on long-term oil prices, not spot prices for crude oil.

Conclusion: don’t expect oil companies to suddenly start spending massively on investment in new oil production

Global oil demand only goes down during deep recessions

Despite progress in the fuel economy of new cars, global oil demand has not gone down but instead has continued to increase in recent years, driven largely by higher emerging market demand from the likes of India and China.

In the last 15 years, we have only seen a reduction in oil demand…

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Harry Hindsight

20th Jun '22

Mr Commodity - putting his bullish spin on the ups and downs of probably the most important market out there. Well food maybe more so - but can always eat cake.

Thanks - bought the story, got caned and now some hope.

Note Shell have bought into (if allowed) a solar project in the Pilbara. Ticks the long ESG box, helps reduce AISC for the miners and presume the sun shines a lot - unlike in the UK where wind and sun of variable quality - shame they don't teach STEM and Geography at ETON or common sense, even more important.

KevinS1

Hi Ed,

I appreciate your weekly musings even if others don't.

Your high-level summary of the oil position aligns with my own thinking - although the moment we get a resolution in Ukraine and/or the world enters recession I am ready to exit pretty sharpish as I suspect either will see a big drop happening very quickly.

I get the feeling that North Sea focussed oil companies will be looking to invest more in the near future to take advantage of the tax breaks, but the larger oilers will avoid it and find lower taxed areas and further diversification as BP (LON:BP.) and £RDSB seem to be doing. The overseas oilers look to be offering better opportunities currently I feel.

I am in both of the funds you mention - Foresight Solar Fund (LON:FSFL) and NextEnergy Solar Fund (LON:NESF) - although I was quite late in investing into them, but both look likely to keep paying a nice dividend whilst they look to grow their NAV's (I hope).

Thanks for your weekly summary - I really enjoy it and it makes a lot of sense.

ACounsell

Thought. It was £BP that had bought into the Pilbara, Australia project?

peterthegreat

Thanks for these musings. My interest in this sector is mainly as a hedge against my fuel bill going up any more, but also perhaps if energy prices fall, the rest of my portfolio may benefit as inflation fears ease. I would make a distinction between oil and gas and a distinction between the US and Europe. Oil is much dirtier than gas and I think it will be replaced with green fuels (such as hydrogen/electric cars) quicker. I anticipate it will take longer to roll-out hydrogen boilers or expensive electric heat pumps than (admittedly expensive) electric cars so I favour gas. I also tend to favour North Sea companies, rather than US ones (where gas is cheaper) as it is so much easier and cheaper to pipe the gas into Europe than transport it with LNG ships which use loading/unloading facilities which are already operating at full capacity. Expanding LNG capacity/transportation is strictly for the big boys because of the costs, so I like Shell's speciality in LNG for this reason and the fact that it is at a substantial discount to big US oil companies. You are certainly right that European oil and gas majors are relatively cheap but some smaller European companies are even cheaper. According to Stockopedia, Serica Energy is on a 2022 forward p/e of 2.9 and its expected earnings over the next 2 years + cash are about equivalent to its market cap so that sounds cheap to me, but not a recommendation. If you want an oblique play on the current energy situation have a look at Hargreaves Services because Germany is expected to re-start its coal-fired power stations and Hargreaves has a pulverised coal production facility in Duisberg in German through a joint venture there, although there are likely to be capacity contraints. Hargreaves's commodity trading operation also looks interesting in the current climate.

Yes sorry BP (LON:BP.) Maybe mind blocked due to their exposure to Rosneft but still caning it in .

So where would Germany obtain its coal. My notes are vague on the matter (keep the mushrooms in the dark). Interesting times.

AnonymousUser1782684

Thank you Edmund for an excellent analysis as always. Please keep them coming!

Cuddlesticks

Super article again. The development of themes into investable ideas is terrific and the research is brilliant. Thank you.

marigold

21st Jun '22

Dont they have their own coal in the ground?

Pentago

22nd Jun '22

big importers of US coal

Oil prices continue to be volatile, but now trading in a band very much higher than reflected in stock prices (and natgas/LNG prices and refining margins are v strong too - a major bonus for the Integrated oils). The bonus here is that oil prices are USD denominated, so buying UK listed majors also provides a hedge against flaky GBP. I am buying copper too on this pullback.

Anthony127

23rd Jun '22

I agree that the current pullback represents an opportunity to invest in energy companies.

Much of the sanctions against Russian oil and natural gas will probably take about 12 months or so to come to fruition as France and Germany try to wean themselves off Russian energy. This will likely increase the price of energy over this period as further shortages should occur.

President Biden's intention to remove fuel tax in the US should increase demand assuming he gets it through congress. I disagree however with his complaint about US Oil firms carrying out buybacks of their shares rather than drilling, as his comment appears to be based on ideology rather than understanding his role as a steward of the economy. It wasn't so long ago that he was advocating new forms of energy and urging companies not to drill for oil.

Market Musings 200622: Oil & Gas correction: opportunity or trap