In recent weeks, the oil price soared past $90 a barrel, and Brent Crude briefly rose above $100 per barrel. Several factors contribute to this rally but with major geopolitical issues on the horizon, views on the long-term outlook for oil and gas stocks conflict. Will the oil and gas price rally continue into 2022 and beyond?
Rising demand, dwindling supplies
People living in the western world have a nice quality of life thanks to oil and gas. The rest of the world is striving to catch up but to do so remain very much reliant on fossil fuels. This is driving up global demand.
However, a recent Energy Information Administration (EIA) inventory report showed oil supplies at Cushing, Oklahoma are at their lowest since September 2018. Cushing's importance to the O&G market is less than it used to be as producers send more inventories to the US Gulf for export. Nevertheless, Cushing remains the delivery point for US crude futures and is still a benchmark worth noting.
Of more concern is that some analysts believe OPEC+ reserves are less than they would have us believe. Indeed, the International Energy Agency (IEA) warned that OPEC+ appears to be struggling to meet production quotas after producing 900k bbl/day under target in January.
Global oil consumption has exceeded oil supply since mid-2020, leading to six consecutive quarters of low global oil inventories.
ESG’s influence on the long-term outlook
To meet government climate commitments and targets, investments are directed at alternative energy methods. Pivoting away from fossil fuels is a global agenda which means less and less institutional money is available to fund new exploration and drilling proposals.
Less supply, coupled with growing demand, will lead to higher oil and gas prices.
With no new money entering the space, only those that can afford to drill will do so. This constrains OPEC member countries' ability to push on.
Thus, it doesn't bode well for smaller energy stocks, while the oil majors stand to benefit down the line. But they too are under tremendous pressure to conform to ESG standards and meet climate targets.
Indeed, climate targets have led oil majors to cut or cancel projects and sell assets to companies operating in parts of the world where ethics can be questionable.
Geopolitical issues: a temporary influence?
Geopolitics can wreak havoc with the oil price, creating wild volatility, but this is often short-lived. Therefore, the threat of war or military conflict between Russia and Ukraine which is currently in the news, could be a temporary influence on the oil price. Given the fear that energy supply chains could be disrupted naturally leads to impulsive buying and selling of stocks.
Similarly, the pandemic initially caused a price shock when a global lockdown instantly slashed oil demand. The oil price plummeted back then, even venturing into negative territory in April 2020.
Generally, when the oil price is high, it lifts the share prices of energy stocks, and the opposite is true when the oil price is low.
However, each individual company must also thrive on its own merits. Therefore, some energy stocks make a better long-term bet than others.
Although the bigger supply/demand picture suggests the oil price will stay elevated, there are concerns some oil stocks are overbought.
Headwinds facing oil and gas stocks
Whether investing in offshore drilling, onshore shale companies or oil services, the industry faces a series of headwinds investors should be aware of.
Throughout North America, wage pressures are wild. In Canada and the US shale patches, energy companies would love to ramp up production but can't recruit the labor without paying higher rates. And the equipment is either impossible to come by or also priced at a premium.
When the oil industry hit a rough patch in 2020, many workers lost their jobs and ended up working in construction. With house prices soaring, the construction industry is booming, and jobs are well paid and secure (for now). A wage hike is a must to entice these workers back to oil.
Meanwhile, supply chain disruption has caused many necessary equipment supplies, such as drill bits and sand, to run out or cost more. Plus, the more prominent companies with deep pockets and industry connections can buy up surplus stock, leaving the smaller companies unable to secure what they need.
The upshot of all of these factors is that oil majors stand to survive while pushing smaller companies out of business. However, even the big players face challenges. Several went through bankruptcy proceedings when oil was priced under $50.
Transocean (NYSE: RIG) is the world's largest owner of deep-water oil rigs. In 2018 Transocean closed a $1 billion, five-year, senior secured revolving credit facility. It increased this to $1.36bn in 2019 before COVID-19 troubles hit. This facility will mature next year.
In 2020, its peers Diamond Offshore Drilling, Valaris (NYSE: VAL) and Noble (NYSE: NE) went through bankruptcy proceedings. They restructured their debts but are now financially constrained and unable to secure more debt. This limits their ability to scale.
Despite growing demand, inflationary pressures are evident throughout the industry. This makes exploration and production (E&P) stocks (upstream) appear safer than other aspects of the industry for now.
Whereas offshore services energy stocks may prove lucrative down the line, they currently face several headwinds which could keep their share prices suppressed.
The industry is ripe for M&A activity, which also influences share prices.
All in all, the workings of the oil industry are complicated. Vast sums of money are necessary to keep it ticking over, along with a high oil price to ensure profitability.
Investors in energy stocks need to be prepared for share price volatility and keep the bigger picture in sight.
It's also important to thoroughly research and understand the individual company you're investing in as inflationary pressures, access to financing, and the broader macro environment all play a part in ensuring longevity.