HIGH PRICES: There are many crosscurrents buffeting oil around $110/bbl. currently. The US and allies are aggressively selling oil from their strategic reserves, whilst demand is cooling from the number one importer China as its zero-covid lockdowns bite. Whilst supply is threatened by Russian embargoes and client self-sanctioning, and more broadly by OPEC bottle-necks. But the greatest medium term driver is the very slow recovery of new investment, despite high oil prices (see chart). This underpins both our ‘high for longer’ oil price outlook and energy sector focus.
CAPEX STRIKE: Global oil drilling activity is the closest proxy to new supply investment. This has dramatically lagged the ramp up in oil prices, to a degree not seen in recent history. Drilling rig counts are down over 50% from prior peaks. This fall has been led by the US, with rising environmental headwinds, bank lending constraints, and investor and management focus on profitability rather than production after the 2015 ‘bust’. By contrast, the Middle East has been the most resilient, where production costs are lower and national oil companies dominate.
HIGH FOR LONGER: Normally the ‘solution to high oil prices, is high prices’. This is no longer working, and the US-led ‘capex strike’ is a key foundation of our high for longer oil price outlook. This will support oil equities (XLE, and @OilWorldWide), that we think have the best risk/reward, with low break-evens, valuations, and strong dividends. This will also accelerate the long-term carbon transition (@Renewables). But it also means stickier inflation for longer.
All data, figures & charts are valid as of 04/05/2022