W
ith oil prices climbing
well above the $70-abarrel level they struck
before the pandemic,
the animal spirits of
commodity sector investors should be
roaring.
Oil traders are certainly excited with
executives and hedge fund managers
predicting that a return to the $100-abarrel era may not be so far away. Brent,
the international benchmark, reached
$74 a barrel this week while US crude
touched $72.
Under-investment has restrained
supply in the sector in advance of peak
demand. Crude traders point to
expectations of a post-pandemic boom
in travel and the wider economy that
should stoke demand for the black stuff,
whatever the long-term goals of politicians to build back better — and greener.
But the fund and investment managers who trade in oil companies rather
than oil prices still appear to be in a deep
slumber, at least compared with their
counterparts in oil futures or physical
markets for cargoes.
Scratch the surface of the bullish
optimism among those trading in oil
itself and it soon becomes clear why
those fund managers that prefer trading
in companies, from “Big Oil” to
shale upstarts, do not quite share their
optimism.
The problem is that the oil market is,
by its own standards, flying largely
blind. In normal, pre-pandemic times,
the industry had become pretty good at
predicting where demand and supply
would roughly be in any given month.
Debates tended to focus on whether
demand or supply would be a few
hundred thousand barrels a day higher
or lower. While that could be enough to
set the tone for rising or falling prices, it
was really a drop in the ocean of a
100m b/d global market. But since last
spring, the oil market has had to learn to
embrace huge swings.
Demand last year fell by 10m b/d
globally. It’s coming back fast now but
traders are adjusting to talking in increments of 1m b/d or more, multiples
higher than the usual monthly changes.
Compounding the issue is the longterm outlook. Demand, most traders
and analysts agree, will peak at some
point thanks to the growing use of
electric vehicles and intervention by
governments to turn their citizens away
from oil.
Peak demand could be in five years or
15, and if you ask a trader candidly
they’ll say there’s no way of really
knowing.
That means we could either be
heading for a supply crunch — as Big Oil
companies scale back investments — or
a glut within a matter of years.
You can see the uncertainty in oil
contracts for delivery far in the future,
which are generally trading at a steep
discount to those for delivery today.
For traders dealing in the underlying
commodity, the uncertainty is
manageable.
It’s an industry that tends to thrive on
volatility and every participant knows
the market can be turned on its head by
a war or an economic crisis, such as in
2008 when oil went from $147 a barrel
to $30 in a few short months.
The prospect of a return to $100-abarrel crude might be enticing but,
given the big physical traders such as
Vitol and Trafigura made a fortune
during last year’s coronavirus-induced
downturn, the direction of travel is less
important than the volatility to their
bottom line.
But for investors in oil companies?
The uncertainty is paralysing. When
JPMorgan surveyed its clients last
month, it found at least as much
trepidation as interest.
While investors might accept that a
return to higher prices is a real
possibility, they are not sold on how long
the move will last, with many expecting
a surge rather than a sustained rally.
One of the best things that could
happen for climate change is a sharp oil
price increase that incentivises the
move away from fossil fuels.
They also have one eye on US shale.
The biggest publicly listed producers in
the US shale industry are, for the
moment, showing admirable restraint.
By finally focusing on boosting
profitability and returning cash to
investors rather than going on a capitalintensive drilling spree, traders can no
longer bank on a significant surge in US
output to meet demand growth.
But can this newfound discipline
really survive a sustained period of
prices above $70 a barrel, let alone
$100? The jury is very much out.
For equity investors, who need to take
a longer term view of possible returns,
the uncertainty is particularly toxic.
That could be an opportunity for those
who think predictions of the end of the
oil age are premature.
But it also could partly explain why
some investors have been pushing
companies from BP to ExxonMobil to
think hard about a future where they
pump less oil.