View from Vox: oil and gas has been the place to be this year, but it faces a bumpy road ahead

John Hughman
View From Vox
14:03, 29th June 2022

It wasn’t that long ago that oil and gas stocks had been cast into the investing wilderness. Environmental concerns and the prospect of a broad market shift to electric motoring had seen the once popular narrative of ‘peak oil’ shift to one of what former Bank of England governor Mark Carney dubbed ‘stranded assets’. 

In other words, rather than there not being enough oil to power the world’s continued growth as was once argued – a view which had, in part, led to soaring prices in 2008-16 - there would instead be huge reservoirs that would forever sit underground, unburnable if the world had any hope of hitting its target of limiting the global temperature increase to 2 degrees and slow climate change.

Even before Covid struck, investors in the oil and gas industry had already started to see the value of their investments deflate in response to this new threat to its future – the fortunes of oil producers are, after all, highly correlated to what was then a dwindling oil price. 

But when the pandemic arrived, demand almost completely evaporated, and oil futures temporarily crashed – for the first time in history – into negative territory, the immediate fortunes of producers went from bad to worse. Shell, amongst others, saw its share price more than halve from its peak, forcing it to do the unthinkable and slash its once sacrosanct dividend. 

Oil's resurrection

There has, of course, been another twist in the hydrocarbon tale in the form of Russia’s largely unexpected invasion of Ukraine, which has helped send the price of oil and gas shooting sharply upwards to new record highs once again. 

Supplies of oil and gas, already tight as a result of years of underinvestment in production and Covid-related industry shutdowns, got even tighter as Russian supply was to all intents and purposes switched off and demand simlutaneously rocketed as the world re-opened. Oil and gas shares, once written off for dead, bounced back with a vengeance, making the FTSE 100 look like the index to be in for the first time in many years and life a misery for pretty much everyone who needs energy…which is everyone.

But what the latest series of oil market crises does remind us of is that the stranded assets theory has so far proved more a case of wishful thinking than economic reality; with the transition to clean energy still a long way off, we’re going to need oil and gas – and coal for that matter - for a long time to come. Battery electric vehicles, for example, still only account for only around 1% of the global fleet, and even as that percentage grows the electricity required to power them will need to come from somewhere. 

Brent crude’s wavering fortunes

Source: SharePad

Yet, as the recent retrenchment of oil prices also shows, the threat of recession can exert a huge downward influence on the oil price. Too high, and consumers and industry simply reduce consumption. The industry really needs a 'goldilocks' price to consistently propser - neither too hot or too cold. 

And we shouldn’t forget the complicated geopolitics of the energy industry, either – as a key component of the current inflationary nightmare, politicians will be exerting as much influence as they can to up output and bring prices down again. If they're succesful, at some point falling demand and rising supply could again meet in the middle and see a really significant oil price correction. 

Canny – and contrarian - investors will have known all of this long before the current crisis emerged, and will have been buying into the industry in the aftermath of the Covid-induced sell off in anticipation of the inevitable recovery in demand as the pandemic faded. Oil and gas has been the place to be as almost everything else has slumped.

But they will also know that it’s a cyclical industry, prone to periods of feast and famine, with long-term secular headwinds, not least from the gathering momentum of clean energy investment which will almost certainly hit a tipping point sooner or later. Be careful not to get stranded when that day comes – oil may have plenty of mileage left in the tank, but its long-term future is likely to prove a bumpy road.

Disclaimer & Declaration of Interest

The information, investment views and recommendations in this article are provided for general information purposes only. Nothing in this article should be construed as a solicitation to buy or sell any financial product relating to any companies under discussion or to engage in or refrain from doing so or engaging in any other transaction. Any opinions or comments are made to the best of the knowledge and belief of the writer but no responsibility is accepted for actions based on such opinions or comments. Vox Markets may receive payment from companies mentioned for enhanced profiling or publication presence. The writer may or may not hold investments in the companies under discussion.

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