The US crude oil benchmark (Western Texas Intermediate) climbed to over US$81 ($109) recently, the highest price seen since end-2014. Crude oil benchmarks in general have also risen along with a slew of other energy commodities thanks to rising demand for oil, although overall demand is notably not yet at pre-Covid-19 levels.
After oil consumption cratered last year thanks to a literal global lockdown on movement, oil demand has rebounded sharply and is currently on a steady and less precipitous rise as compared to energy prices. On the outlook in the coming quarters, the Organization of the Petroleum Exporting Countries (OPEC) has lowered the forecast for oil demand in 2021 likely over concerns of the Delta variant slowing down economic activity for much of the year.
Oil demand is however also expected to rise on gas-to-oil switching
With natural gas prices recently having doubled from pre-pandemic prices in just a matter of months on surging demand (the UK is seeing a +700% increase in natural gas prices over the past year), we are currently seeing widespread “gas-to-oil” and “gas-to-coal” switching on the demand-side, as utilities companies switch from natural gas to now more practical crude oil and coal commodities to meet energy needs. Thus, crude oil demand in the final quarter of the year is expected to receive a year-end boost.
However, a word of caution may however need to be inserted here — there are only a limited number of “oil-fired” power plants in North Asia and Europe, meaning that any switch in demand from natural gas to crude oil may find a natural limit on its capacity — particularly in cheaper Low-Sulphur Fuel Oils (LSFOs).
Furthermore, signs are emerging that coal usage is on the rise across all the major economies — the US, Europe, China and India — perhaps somewhat a surprising backtrack to some, given relatively frenzied investment and regulatory action on cleaner energy generation over the past year.
For instance, Chinese coal imports recently rose +18% month-on-month, while US coal plants are on track to burn up to +23% more coal this year. While supply chain and sheer production capacity limitations would limit how much coal can substitute natural gas for power generation, it is likely that some expectations of a massive spike in crude oil demand in the near-term are likely overdone.
In short, oil demand is forecast to rise to make up for natural gas shortfalls, but the near-term price squeeze may be unrealistic given the structural limitations of switching natural gas power generation for crude oil on such short notice.
Energy prices are more-or-less back at pandemic levels
Moving on, the BCOMEN chart — made up of futures contracts on crude oil, heating oil, unleaded gas and natural gas — is now back to pre-Covid-19 levels, a particularly remarkable spike given that the world saw negative oil prices only as recently as last April.
Cuts in natural gas exploration/production in 2020 means near-term relief is unlikely
Natural gas has understandably contributed to an outsize spike in energy prices in recent months due to the aforementioned doubling in its price. Investment in natural gas exploration and extraction saw cutbacks early into the pandemic last year, and the world’s economic recovery — and demand for natural gas — has been a lot stronger than anyone in the energy sector has seemed to have anticipated.
Given the bleak outlook for supply to increase by enough to match rising global demand however, it is likely that the spill over in demand for other sources of fuel such as coal and crude oil will continue driving energy prices past its pre-Covid-19 levels — at least for a spell.
In short, energy prices are now at pre-pandemic levels, and are expected to continue rising as logistical issues continue to provide a headache of unprecedented magnitude to the world’s supply chains.
How are energy stocks doing?
Make no mistake, traditional energy stocks have long been a laggard in the S&P500, being consistently placed at the bottom of the pack in terms of returns year after year for the better part of the past decade. Oil companies such as Petroleo Brasileiro (-29%) and Exxon Mobil Corporation (-13%) are still down from the beginning of 2020.
Using the S&P500 Energy Index (S5ENRS) as a benchmark, we can see in Chart 3 that the S5ENRS has lagged the stock market through 2020 and 2021, somewhat continuing over a decade of underperformance against other stock market sectors (although energy stocks did give market-beating returns for investors with a shorter time frame from end-2020 to the middle of this year).
In short, energy stocks have tended to underperform the wider stock market over longer time frames but may be attractive near-term plays.
Have you considered alternative energy stocks?
Zooming out, virtually all kinds of energy commodities and stocks are seeing upgrades in sentiment that perhaps warrants investor attention better. For instance, stocks in “alternative” energy such as SolarEdge Technology Inc (+222% since 2020) and Gevo Inc (+56%) have largely beaten the market, with sector benchmarks in Solar Energy (Invesco Solar ETF: +176%) and Uranium (Global X Uranium ETF: +160%) easily beating returns found in benchmarks just about anywhere.
The Global X Uranium ETF in particular is up +83% ytd, rising over +60% since mid-August as energy crunch worries continue to grow and speculation over the need for suitable energy substitutes rise.
However, further rises in the sector have yet to reckon with the nuclear power industry’s biggest obstacle — politicians. While the world’s need for energy is dire, it remains to be seen if countries around the world will turn to nuclear power, in a period where major economies such as Germany and Japan have increasingly sought to distance themselves from nuclear power generation in recent years.
Solar and wind energy may see near-term choppiness
In the meantime, solar and wind energy is growing at a breakneck pace in terms of capacity installation, and likely needs no introduction to most investors regarding their potential.
However, besides making only a small contribution to the power grids of major economies, the past month has seen disruptions in renewables. While the European Union appears to have been largely successful in deploying renewable energy generators, other countries have seen intermittent power from a mix of solar, wind, and hydroelectricity, thus being left helpless to alleviate the shortfall in power generation from disruptions in fossil fuel supplies.
Where does that leave us?
It perhaps remains to be seen how nations will deal with the fallout of the ongoing energy crisis. Discussions in the coming quarters are likely to bring up how renewable energy sources have fared during this period, and our first clues may come in the COP26 UN Climate Change Conference, which begins at the end of October.
With carbon emissions this year forecast to reach pre-pandemic levels despite how central climate change has been to politicians worldwide, it may be more of a question of what renewable energy source the world chooses to focus on, rather than a return to relatively more reliable fossil fuel power generation methods.
Alternate energy — such as solar, wind or even nuclear — will likely see continued interest in the coming quarters. Also, solar and wind energy may see near-term headwinds due to its recent underperformance in some economies.
Finally, will nuclear energy make a comeback? Political developments over this are sure to make headlines in the coming quarters as the energy crisis in Europe deepens and should be monitored.
Mooris Tjioe is an investment analyst with Phillip Futures
Cover image: Bloomberg
