To say that investors are again bullish on oil would be an understatement. In a year that has started with serious uncertainty — primarily about the path to interest rates and tech stocks — a positive call on oil is as close to consensus opinion as it gets.
In fact, traders are again betting that the US oil price will rise above $100. It will take a huge jump to get there. US benchmark West Texas Intermediate (WTI) crude futures were down 0.2% at $78.72 a barrel on Monday.
“This year we have yet to experience a market downturn, whether on the commodity side, with equity investors or corporate clients,” RBC Capital Markets analyst Michael Tran wrote in a note on Sunday.
“Over the past week, the Open Interest for the June 2022 WTI 100 Call has increased by 10%,” he wrote. “Since September, open interest has increased 14 times between $105-$150 per barrel strike prices.”
There are several reasons for the rapid revival. For one thing, oil prices and stocks have proven resilient over the past year. Unlike in previous years, producers remained disciplined, opting not to accelerate drilling to take advantage of higher prices.
Bank of America analyst Doug Leggett wrote Monday that improved performance, and a general understanding that the energy transition will take time, have made “old energy” stocks “relevant.” He expects the stock to regain its 5% weighting in the S&P 500, down from its double-digit weighting more than a decade ago, but well above its 2% weighting in 2020.
The sector is starting the year in a good shape. The Energy Select Sector SPDR Fund (XLE) is up 6.3% year over year, even though the S&P 500 is down more than 3%.
And while the oil market has both bullish and bearish risks, the bullish ones are more apparent today.
For example, multiple geopolitical risks can push prices higher. Russia’s military build-up on the Ukraine border has had a major impact on oil and gas prices. If Russia invades, oil prices will almost certainly rise as countries around the world impose punitive sanctions on the country. Tran calls it “buy now, ask questions of the aftermath type of event risk for the oil market” and expects an attack to propel average oil prices to $6.40 a barrel in the second quarter.
Production and exports to other countries are also at risk. Libya’s output has recently declined after infrastructure was damaged. And it is unclear whether the US and Iran will come to an agreement on a new nuclear deal and lift sanctions for oil exports. Analysts were optimistic about a deal last year, but the stalled talks have dampened hopes.
In general, there are growing concerns that supply is growing too slowly, and that OPEC may not have enough spare capacity to ship around the world if demand begins to exceed pre-pandemic levels. Tran doesn’t think OPEC and its allies (known as OPEC+) are adding supplies as quickly as the group has estimated.
“OPEC+ remains determined to add back 400 kb/d to the market every month, but our data suggests monthly additions are closer to 250 kb/d,” Tran wrote. “This amalgamates the 14 million missing barrels in the previous quarter that were penciled into balances that have yet to be shown.”
More evidence of a supply crunch would be extremely bullish for oil prices. The more countries have to compete for every barrel of export, the higher prices can go.
Write to Avi Salzman at [email protected]