Yahoo Finance Opportunities available to investors as oil bounces back
After a spectacular crash during the early days of the coronavirus pandemic, oil prices have surged to multi-year highs. With talk of a looming global energy crisis, what's the outlook for oil?
Demand for oil understandably plummeted as much of the world went into lockdown, but demand is bouncing back as the economy shifts into gear.
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There are several factors at play. The strong outlook for oil is not just due to recovering economies, but also anticipated extreme weather, stockpiling and the impact on oil production of adverse weather events like Hurricane Ida in the US.
Natural gas prices have soared to record levels in Europe and hit seven-year highs in the US, making oil a more economical alternative for power generation.
As a result, West Texas Intermediate (WTI) crude futures - the US benchmark for oil prices - leapt above US$80 per barrel in October – its highest level since 2014.
It's a similar story with Brent crude prices - the international benchmark.
Many analysts believe they can go higher, and it's little surprise the energy sector is far and away the top-performing S&P 500 group this year.
Soaring oil prices have led to stellar earnings reports from oil companies. BP announced a $3.3 billion profit, beating estimates, with rising energy prices the catalyst.
Meanwhile, Exxon and Chevron, the two largest oil companies in the US, reported their most profitable quarterly earnings since before the pandemic.
As demand for oil rises, supply has failed to keep pace – further driving up the price.
OPEC slow to increase output
The Organisation of the Petroleum Exporting Countries (OPEC) and its partners cut oil output last year and have been slow to boost it again.
OPEC recently decided to maintain its increase in production by 400,000 barrels per day, despite the jump in price. This fell far short of market expectations of a larger increase of 800,000 barrels.
This limit on supply comes despite US President Joe Biden repeatedly asking OPEC+ – consisting of OPEC and a Russia-led group of oil producers – to consider raising output to further support economic recovery and draw lower prices.
Considering all this, analysts at investment bank Goldman Sachs recently upgraded their year-end Brent crude oil price forecast to US$90 per barrel.
Meanwhile, analysts at JP Morgan recently said oil could potentially go as high as US$150-US$200 per barrel.
The short-term outlook for oil is clearly strong, assuming tight supply as the global economic recovery continues on its current trajectory. Especially if the coming winter in the Northern Hemisphere is cold.
However, investors should remember that market conditions can change quickly, as we saw in 2020. Oil prices are notoriously hard to predict. Therefore, it's always suggested that investors diversify and focus on high-quality companies.
Going forward, much rests on OPEC's strategy in 2022. It appears reluctant to turn on the tap too quickly and risk oversupply, similar to what we saw in 2020.
Yet oil demand generally tracks economic growth, often supporting producer profitability with the growing economic environment.
All things considered, it's likely OPEC will succumb to pressure and gradually increase supply next year, which could see oil prices lower by the end of 2022 than they are now.
Demand for cleaner energy
Looking at the bigger picture, there is also the impact of the worldwide push for cleaner energy, on the back of concerns over climate change and sustainability.
By 2030, sustainable sources such as solar, wind and hydropower are expected to account for around half of the global energy mix, compared to just 11 per cent in 2019.
That's a significant shift, but it doesn't necessarily spell doom and gloom for oil in the short to medium term.
Right now, the traditional energy sector is working hard to attract investors.
Most have increased dividends and are attempting to appeal to new investors with green energy or low-carbon business plans. For example, Exxon increased its low-carbon spending in Q3, saying it would invest $15 billion on projects from 2022 through to 2027.
The rise in the price of traditional energy commodities like oil is also partly driven by the underinvestment in fossil fuels, as countries around the world pivot toward renewable energy sources that presently lack the bandwidth to meet consumer needs.
Oil prices have soared in response to Europe's so-called ‘windless summer’, which saw much lower-than-normal renewable power production in the UK and Germany. This was compounded by difficulties in accessing Russian gas.
Despite the world's efforts to go green, the transition to renewables seems destined to be more complicated than anticipated and take longer than expected.
While long-term investors should have an eye on renewable energy, all of this points to ongoing demand for oil.
For now, the world still very much runs on energy derived from fossil fuels, but we can see that the world is transitioning to a future away from fossil fuels.
In the short term, oil is likely to thrive, but production increases in 2022 could halt its progress.
Josh Gilbert is market analyst at eToro.
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