When the pandemic hit last year, it destroyed oil and gas stocks. But their prices have gradually been climbing and 2021 looks to offer a more prosperous outlook for the sector.
Many people see the death of oil as a welcome solution to combating climate change. But this is not a realistic view. We are hugely reliant on oil. Not just for heating our homes, running our cars, and delivering goods around the globe. Oil powers the modern industrial world.
Why do we need oil?
Oil is a vital ingredient in the manufacture of many refined products. A random selection includes everything from crayons and glue, to coatings for pills, plastics, cosmetics, clothing, construction materials, fertilisers and much more.The pandemic caused an immediate halt on demand for oil because it brought the entire travel industry to a standstill. And lockdowns in place meant less traffic on the roads. There is also massive pressure on governments globally to reduce their reliance on fossil fuels and move into more renewable alternatives. This is hugely important to meet the Paris accord.
The price of oil is rising
The price of oil has now recovered to its pre-pandemic levels, which is sending a signal of hope that life may be on route to normality. Both Brent Crude and West Texas Intermediate (WTI) are now over $60 a barrel. Meanwhile Natural Gas prices are soaring in response to a cold snap across the US.
It’s a very long way from the dark days of April 2020 when the pandemic ground global economies to a standstill and WTI bottomed out at just under $17.
There are several reasons. The vaccine rollout is well underway in many countries and Covid-19 infection rates are dropping, leading some to believe the worst is behind us.
While airline oil consumption has been crushed, there’s been an increase from the rise in ecommerce. This has driven demand from delivery trucks and manufacturers of plastic packaging.
Meanwhile, across Asia, things appear to be getting back on track and demand for oil is picking up here too. Asia, Africa & South America are all striving for a larger middle-class population, which will increase oil demand far into the future.
The oil price is also rising on hopes that the US stimulus will help invigorate the US economy. A less pleasant reason is from fighting in the Middle East where tensions are again rising.
The oil price is prone to volatility
The price of oil is notoriously volatile and rises on geopolitical tensions, of which there’s been no shortage in recent years. Before the pandemic hit, Saudi Arabia’s crude production was knocked out by a drone attack. Trump’s sanctions against China inflated oil prices and Trump also initiated sanctions on Russian state-owned Rosneft.
In 2019 Russia failed to comply with previously agreed Opec+ cuts, and in March 2020 Saudi and Russia both contributed to an oil price war that ultimately prolonged the oil price pain. Speculative reports believe Russia’s reluctance to comply with Opec+ was in retaliation to the sanctions on Rosneft but this was not confirmed.
Nevertheless, in April and June, OPEC+ did persuade the two nations to agree to further production cuts. This week Vladimir Putin has been in discussions with Saudi Crown Prince Mohammed bin Salman. They underscored their willingness to continue close coordination between Russia and Saudi Arabia in the interests of maintaining stability in the global energy market.
Telephone conversation with Crown Prince of Saudi Arabia: countering the coronavirus, situation in the oil market https://t.co/KqSZNZ6CU6
— President of Russia (@KremlinRussia_E) February 15, 2021
Vladimir Putin and Crown Prince MBS discuss maintaining stability in the global oil market.
Can the renewables transition benefit oil?
All of this recent supply restraint is set against a wider backdrop of a signalled move away from fossil fuels by many developed economies. The freshly inaugurated 46th President of the United States wasted no time in nailing his colours to the mast.
In his first day in office, President Biden moved to re-engage with the Paris climate accords; revoke the permit for the Alberta to Nebraska Keystone XL oil pipeline and halt oil and gas drilling at Bears Ears and Grand Staircase-Escalante in Utah. Renewables are expected to be looked upon more favourably by the new administration.
All of which sounds like bad news for the gas and oil sector. However, perhaps counter-intuitively in the current anti-fossil fuel climate, there are commentators who see the transition from carbon-based energy to renewables as a buy sign. Peak oil is not here yet and, until it is, the world will continue to buy the black gold. As Oil Price, consultant David Messler points out ‘fossil fuels will become scarcer, and that is bullish for prices’.
Texan deep freeze
Freezing conditions across Texas are taking its toll on the energy grid in spectacular fashion as the state’s electric grid operator imposed rotating blackouts.
There’s been a mass exodus from California to Texas in recent months. This is in response to the rising taxes and strict Covid-19 response in the sunshine state. In an ironic twist of fate, those welcoming the escape from raging wildfire induced blackouts are now experiencing the same outcome caused by weather of the opposite extreme.
However, it’s also prompted an emergency response as refineries are forced to shut in.
Elon Musk on oil
Tesla could be considered the frontrunner of electrification, but even founder Elon Musk understands that fossil fuels will need to be phased out gradually.
Speaking to Joe Rogan last week Musk said:
I’m not in favor of demonizing the oil and gas industry. Because like we can’t stop instantaneously and not have oil and gas. You know, like, we’ll likely die of starvation basically. We’re going to need to burn fossil fuels for a long time—the question is just at what rate do we move to a sustainable energy future. So, I think we should probably move there faster than slower.
He also went on to say he’s in favour of a carbon tax, which he believes would solve the problem of laying the blame of climate change at the feet of the oil giants. Instead giving consumers the option to make sensible choices based on cost.
However, he also said he’d suggested a carbon tax to the Biden administration, and they didn’t seem too keen as they think it will become too politicised. Both Rogan and Musk found this very disappointing, considering Biden’s focus on a green economy.
Both Rogan and Musk recently moved from California to Austin, Texas. Musk recently announced he plans on drilling for natural gas at a South Texas site. This is to power his SpaceX Starship rocket to Mars.
Sleepwalking into a supply crunch
There’s no denying that most of 2020 was a rocky year for oil but the challenges it faced have set the scene for a possible bull run. Demand crashed from last March as Covid closed economies. The resulting oil glut sharply depressed the price of oil and, in response, exploration and production companies drastically cut investment.
Last December, a note from Simon Flowers, Chief Analyst at Wood Mackenzie, put oil and gas investment at a 15 year low:
Budgets in upstream oil and gas were slashed again in 2020, and we expect spend in 2021 of just US$300 billion, 30% down on 2019, 60% on the 2014 peak… The world may be sleepwalking into a supply crunch, albeit beyond 2021. A recovery in oil demand back to over 100 million bpd by late 2022 increases risk of a material supply gap later this decade, triggering an upward spike in price.
Embarking on an oil bull run
One of the most bullish oil voices of late has been Tom Lee, former Chief Equity Strategist at global investment bank JPMorgan, and now the founder of independent research firm FSInsight.
Last week, he issued a note in which he weighed up the chances of energy stocks doing a Tesla and staging a ‘parabolic’ surge 2021. His theory is that many institutional investors are underweight in energy.
As commodities such as oil rise in price, FOMO, or the fear of missing out, will drive investment from fund managers. He also thinks that the ‘re-alignment of the supply/demand outlook for Energy is the most dramatic of any sector’.
Tom Lee, founder of independent research firm FSInsight.
Like Tom Lee, the IEA’s monthly report takes a positive view for oil but their stance is more cautious. It states that ‘crude prices are well supported by financial, economic and market fundamentals’. However, for the IEA, a current resurgence in Covid-19 cases is slowing the rebound.
On the plus side, they expect stronger growth in the second half of the year as vaccination campaigns roll out and economic activity accelerates. Estimates vary but some commentators predict that the global economy will grow 4-5% this year.
Future outlook
Stopping oil production completely is impossible. So even with cuts, it can lead to oversupply. However, it looks as if demand is slowly increasing and this should accelerate as lockdowns are eased.
There’s no doubt an environmental push to reduce CO2 emissions is going to reduce demand for oil in the long-term but it’s not going to kill the sector. In fact, many within the oil industry believe the withdrawal of capital from Oil and Gas, along with a mismatch between supply and demand, will lead to a steep rise in oil prices in the coming years.
A rising oil price boosts exploration
When the oil price is low, lots of projects are abandoned because it’s not economical to proceed. But it’s well known that when the oil price goes up, the rig count goes up too. That’s because above a certain point many previously uneconomical projects or jurisdictions suddenly become attractive.
Reconnaissance Energy Africa Ltd. (TSX-V:RECO | OTCQX:RECAF | FRA:0XD) otherwise known as ReconAfrica, has petroleum exploration licences for the Kavango Basin in Namibia and Botswana, which covers an incredible 8.5 million acres.
It’s easy to miss exciting investment opportunities when there’s so much information vying for our attention. ReconAfrica is one such story that may have been lost in the noise. It’s unique advantage is that it’s unlocking the potential hidden in undeveloped onshore oil basins.
Its share price has already rocketed 94% year-to-date and is up a whopping 364% in a year. The company’s market cap is only $381 million, but the scope of its assets offer so much more potential.
It’s worth noting big players like Royal Dutch Shell and Exxon are expanding exploration in the region and any discovery at the Kavango Basin could make ReconAfrica a prime target for partnership or even potential acquisition.
The risk-reward ratio for investing in oil and gas stocks is higher than other sectors because of the volatility. When the oil price rises, naturally oil stocks rise too. But due to so many simultaneous influences there will always be fluctuations in the oil market. As long as investors keep a reality check on the overall situation it can be an exciting sector to invest in.
