DIVERGENCE: Oil equities have been resilient to falling oil prices, given their cheap valuations and with current prices still well over four times the average production cost. Oil majors are an attractive hedge to the risk of ‘high-for-longer’ oil prices. The current focus on recession risk and the backwardated oil futures curve under-appreciates the big potential supply shocks. From a near end of US strategic reserve (SPR) sales, to still low drilling activity, and Europe’s coming Russia embargo. The risks are also more than oil. Lower oil is a key anchor for global inflation. Especially as other prices, from housing to wages, are frustratingly sticky. See @OilWorldWide.
COMMODITIES: The risk of ‘high for longer’ oil prices is driven by supply, with demand risks well-known and new Iran production a wild-card. 1) US is nearing the end of its huge SPR sales, with 165 million barrels of the planned 180 million done. The focus will shift to the long term SPR rebuild from 38-yr lows. 2) Global drilling remains depressed, still 50% below its previous highs. 3) Europe’s December 5th embargo on Russia oil imports will see it looking for 1.5mbd of product from elsewhere. 4) Whilst oil futures markets are heavily backwardated, a price positive.
EQUITIES: Oil equities, proxied by the XLE oil exchange traded fund, are down by 13% from recent highs vs 31% fall for Brent crude (see chart). Resilience is driven by 1) rising earnings forecasts, up 8% since the start of Q3. In the same time crude fell by 25%, as equities never priced in $120 oil. Consensus is now for 150% earnings growth this year vs S&P 500 8%. Plus big 3% dividend yields. 2) Current oil prices are multiples of c$20/bbl. average production cost. Producers see $90/bbl. as a ‘better’ and more sustainable price than $120. 3) Energy is the 3rd cheapest of all thirty US industries, on 9x forward P/E, only slightly ahead of telcos and banks.
All data, figures & charts are valid as of 20/09/2022