For the first time since 2018, the price of Brent's barrel has just surpassed the 80USD mark, while European natural gas stocks, usually full at this time of year, pending the Winter, have not been restored. The coming months will therefore be tense on energy markets, and consumers will likely lose out. Nevertheless, some countries will benefit—a brief overview.
A sector short of funding
At the time of the energy transition, hydrocarbons are denounced. Nevertheless, they are still necessary and make up an essential part of the energy mix of most countries of this world. This is all the case as other energy sources such as coal are also on the way out, as is nuclear in some countries, such as Germany. However, the energy transition will take decades, and at this point, we cannot (yet?) do without hydrocarbons.
However, to continue to produce them, investment is needed. And the investment is proving more and more difficult to obtain for companies in the sector because of their bad image and the rise of ESG criteria. As a result, investors and investment funds deviate from oil and gas, considered too polluting. And in the end, the entire world of finance is distancing itself from the hydrocarbons, banks and insurers that cut their bridges with oil and gas.
The movement began with restrictions on oil sands or the Arctic drilling financing, many of which European banks have deviated since 2017-18. But today, this goes much further, with several major financial players excluding the entire hydrocarbon sector from its funds or investments. Among them are some Scandinavian banks and the heavyweight of the equity markets, the Norwegian sovereign fund.
For all these reasons, investment in the oil and gas sector is at half-mast. And without investment, it isn't easy to increase production capacity or even sustain it at current levels.
The most telling example of this phenomenon is in the United States, where American shale oil, which had for a time hoped for the country's energy independence and allowed to temper the price of the barrel in recent years, has not restarted. As a result, American producers in the sector became very afraid in 2020, when the sudden drop in crude prices to negative levels had precipitated the bankruptcy of many of their colleagues. At this stage, they prefer to focus on profits because they earn thanks to high crude prices rather than investing in producing more.
Courses that are blazing
The supply is therefore weakened, and, at the same time, the demand for energy increases as the economy leaves the impact of the pandemic behind and recovers a semblance of normality. The result of this increase in demand in the face of stagnant supply is an increase in hydrocarbon prices to levels that had not been experienced for several years.
At more than 83USD per barrel during the session, the Brent is at its strongest since 2018. Close to the 80USD, the US WTI barrel has been at its strongest since 2014. Significantly, the rise in oil prices is hardly comparable to the increase in natural gas prices. In Europe, gas delivery contracts have seen their price explode since the beginning of the year, going from 18.7€ per Mw/h on January 1st to more than 107€ today (see chart).
At this price, the energy equivalent of a barrel of oil in gas is traded at nearly three times the oil price. Europe thus pays its dependence on Russia. But, in the process of replenishing its gas reserves, the country is also reviewing its customer portfolio, moving increasingly towards Asia - and in particular China, which is one of its allies - to the detriment of exports to a hostile Europe.
A dangerous transition strategy
Therefore, we are witnessing a return to the past. The whole world is watching the decisions of Opec and Russia and is calling on it to increase its production to meet growing demand. The ultimate aim of the West's demands is to limit the rise in oil and gas prices, which boost inflation and weigh on purchasing power, industry and, ultimately, economic recovery.
So naturally, it is Opep and Russia that are accused of causing the oil price spike. But we have to face the facts: the West has either abandoned hydrocarbons too fast or been too slow to invest in renewables - more than likely a mixture of the two. So if it is now short of options for its energy supply, it is because of this perfectible strategy.
Therefore, the energy crisis we will be going through this Winter may well be just the first in a long series since the challenges of the green transition will not be solved overnight.
A negative impact on the global recovery
As a first step, it is unlikely that soaring energy prices will affect monetary policy in Europe and the United States. This is because the inflation indicators favoured by central banks on both sides of the Atlantic exclude volatile prices such as food and energy. Central banks will therefore continue to do what they can to support the recovery.
Nevertheless, no doubt, rising energy prices will surprise consumers and weigh on their purchasing power. It will also consider European industry in general (and German in particular), a large part of which is gas-fired.
This is an additional threat to the competitiveness of European production and industry activity as a whole. The surge in prices, therefore, poses a significant risk for the recovery, particularly in Europe.
This will also lead to increased nervousness in both equity markets - whose price level anticipates an idyllic scenario for the global economy in the coming years - that for the bond company, which continues to have as its main scenario of transitional inflation. The energy crisis may well become the most considerable risk for the post-pandemic world.
But positive for some markets
However, not everyone is a loser in this oil spill. Since the beginning of the year, Russia has been one of the best-performing equity markets, posting a 37% gain (price and dividend, in €). Norway (27%) and Canada (26%) followed. And with an increase of 18%, Mexico is not lagging.
We continue to invest in Russian (undervalued market despite recent performance) and Canadian equities as part of our neutral and balanced portfolios. For Norway, we support through the bond market. On the other hand, we are staying away from Mexico, where a very perfectible governance has long been masked by the shape of the US market and the surge in energy prices but risks returning sooner or later to the front of the stage.
The hydrocarbon sector is at a turning point
The oil companies will have to learn to do without oil. They will have to undertake this effort to transition to green energy because more and more investors are pushing them in this direction, themselves under the influence of their shareholders.
Evolution towards less oil extracted by oil companies there will be. However, it will be slow because the world is still thirsty for oil, as shown by the current consumption of black gold approaching 100 million barrels/day and the level of before health crisis (100.3 million in 2019).
Moreover, investments in these energies are high and will not generate profits for several years. American companies such as Exxon, Chevron or ConocoPhilips are very reluctant to take this route and prefer to increase hydrocarbon production. They are betting on a still substantial increase in oil demand in the coming years. On the other hand, Europeans are at the forefront of the transition. Most expect production to decline in the coming years.
Investments will be geared towards greener options and less towards oil. As stated above, this will happen (and is already happening) in the sector and all economies.
Our recommendation
The oil sector is trading at about 12 times the expected profits, which is not very high and still reflects a certain distrust of investors. Moreover, the rise of ESG funds that focus on preserving the environment and refusing to invest in oil leads us to adopt a cautious approach.
For the moment, this compartment is well oriented in the Stock Exchange, but it still depends on the price of the black gold barrel. Moreover, by its volatile nature, the latter relies on the will of OPEC and its allies to keep production under control.
If you want to focus on the energy transition, you may always opt for a specific fund or ETF that has this objective.