After a slow start to the year, energy has emerged as the sector to watch with crude oil futures soaring to a five-month high in the wake of escalating geopolitical tensions in the Middle East. Iran has vowed revenge on Israel after an airstrike on its embassy complex in Syria on Monday left two top generals and five military advisors dead, while yet another Ukrainian drone attack has struck one of Russia’s biggest oil refineries. WTI crude for April delivery has rallied to $86.76 per barrel while Brent May futures rose to $90.98.
Lately, the energy sector has garnered the most momentum amongst 11 U.S. market sectors after rocketing 11.5% over the past 30 days; in comparison, the utilities sector has posted the second-highest gains after climbing 6.6% while the S&P 500 has notched 1.3% higher over the timeframe.
“It’s headlines, not fundamentals” that lifted WTI, Mizuho’s Robert Yawger says, adding the biggest impact by the Middle East conflict has, so far, been to raise the cost of transport and insurance for ships plying the Red Sea. However, he has conceded that the latest strike in Syria “just ticks that much closer to dragging Iranian production into the conflict. Despite a flurry of diplomatic activity meant to turn down the heat on the situation, there is definitely a chance the Iranians response will not be as measured this time,” Yawger says.
However, not all analysts think that the oil price rally is merely being driven by headlines and sentiment. Commodity analysts at Standard Chartered have predicted that oil fundamentals remain strong and oil prices are set to trade in the lower $90s. StanChart has pointed out that fundamentals in oil markets remain strong, leaving OPEC with ample room to increase output in Q3 without either causing inventories to rise or prices to weaken.
According to StanChart, one of the remarkable features of this year’s oil price rally is that market bulls have largely been missing in action. StanChart notes that Wall Street remains guarded about the oil price outlook, with the analysts’ Q2 Brent forecast of USD 94/bbl currently the only forecast above USD 90/bbl among 34 Wall Street forecasts. Indeed, both the median and the mean of the Q2 Bloomberg consensus panel currently stand at USD 83/bbl, virtually unchanged from the beginning of the year despite the markets tightening considerably. StanChart notes that even erstwhile oil price bulls have relatively low Q2 price forecasts. The bearish price views would be justified if fundamentals were looking weak, inventories were high and/or’ OPEC policy appeared uncertain or if geopolitics appeared benign. However, StanChart points out that none of these conditions hold, with the exact opposite being true. StanChart concedes that this cautious approach may yet prove to be correct, but says that several months of tighter fundamental readings and a near USD 15/bbl YTD price rally could finally persuade the bulls to cross the aisle.
Further Oil Price Gains
The latest Petroleum Supply Monthly (PSM) data released by the EIA on 29 March puts the all-time record high for U.S. crude oil output at 13.295mb/d, which was the country’s average output in both November and December 2023. StanChart has, however, predicted that U.S. output will remain flat with the all-time high not likely to be surpassed until August 2024 and again in October.
StanChart reckons that the U.S. market swung into a deficit of over 1.7 mb/d in both February and March, with the seasonal recovery in demand offsetting the recovery in U.S. output from its January low. The commodity experts estimate there was a counter-seasonal Q1 inventory draw of 1.12 mb/d, which led to a significant tightening compared with the inventory build recorded in Q1-2023. StanChart attributes the ongoing oil price rally to the 3 mb/d relative improvement from Q1-2023, and sees further price gains coming in Q2-2024.
Thankfully for the bulls, a section of Wall Street is beginning to warm up to oil and gas stocks.
According to Citi, Energy (XLE) is now the most crowded U.S. quant factor, noting that the sector tends to underperform over the next one to six months when it becomes red-hot. However, not everybody is convinced by the energy sector’s huge momentum. Meanwhile, Morgan Stanley remains pessimistic about the U.S. stock market in general; however, MS has upgraded energy stocks to overweight from neutral, noting that energy companies have lagged the performance of oil, and the sector is favorably valued.
“Taking the Fed’s recent messaging into account and assuming it is less concerned about inflation or looser financial conditions, commodity-oriented cyclicals and energy, in particular, could be due for a catch-up,” they have said.
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