Is the drop in oil inventories triggered by Omicron a buying opportunity?

Oil stocks appear to have been one of the first victims of the new COVID variant. Investors shunned the world’s largest oil producers on Friday after the World Health Organization said the highly transmissible Omicron, first discovered in South Africa, was “a variant of concern.”

The ETF Vanguard Energy Index Fund (NYSE 🙂 – whose top 10 holdings include Exxon (NYSE 🙂 and Chevron (NYSE 🙂 – fell about 5% on Friday amid speculation that Omicron’s spread could slow the global economic recovery, undermining demand for energy products.

Before this new development on the pandemic front, oil stocks were flying high. The VDE has risen more than 50% so far this year, achieving more than double the gains per barrel, with the United States surpassing $ 80 a barrel in October, for the first time since 2014. oil production, everything continuing to rise, has struggled to catch up with the surge in consumption.

But the new viral strain, if it proves to be more deadly than previous ones, could weaken that recovery, forcing oil companies to once again conserve cash. , the benchmark grade for more than half of the world’s oil, fell nearly 12% on Friday, fearing Omicron would force countries to impose new restrictions and restrict air travel.

Israel has banned entry for foreign nationals as more countries report their first cases of the Omicron variant, the Wall Street Journal reported. Australia, the Netherlands and Austria have joined a group of countries, including the United Kingdom, Germany, Belgium, Israel and Italy, which have detected a strain which authorities say could be at increased risk for people to get sick with COVID-19 a second time and may be more transmissible than other variants.

Structural underinvestment; Higher prices for longer

We see this latest drop – and potentially further losses in the coming days – as a buying opportunity for investors in energy trading. Virus or not virus, the supply-demand equation in energy markets is changing, so that the biggest producers do not want to invest and drill more.

The new dynamic, triggered by climate change and accelerated by the pandemic, means companies are under pressure from their shareholders to limit spending and return more cash, causing structural underinvestment in new production that could keep prices going. higher oil prices for longer.

Jeff Currie, head of commodities research at Goldman Sachs Group, told Bloomberg in a recent report that it made sense for investors to stick with oil for a long time in the current environment. “My advice to customers is that you want to stay on oil for a long time until you know where that break-even price is” which is bringing new supplies online, he said, adding:

“We know it’s above those levels because we haven’t had a big increase in capital spending and investment.”

Among banks that see higher prices for longer, Goldman says $ 85 for 2023. Morgan Stanley has raised what she calls its long-term forecast from $ 10 to $ 70, while BNP Paribas sees crude at close to $ 80 in 2023, according to the report.

CLC weekly TTM

The latest earnings reports from some of the world’s largest energy producers have validated this view. , which generated the largest free cash flow in its 142-year history in the third quarter, told investors it intended to keep capital spending 20% ​​below pre-COVID levels next year while increasing share buybacks. The same goes for, which increased its quarterly dividend last month, as it pledged to maintain its spending discipline.

Final result

With this favorable supply-demand equation, it makes sense to have at least a small allocation of energy stocks in your portfolio, especially stocks that pay more cash in the form of dividends. The current pullback could open such a window for investors currently on the sidelines.

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Felix J. Dixon