Material Matters: Oil & Gas

Commodities | Jun 16 2022

A glance through the latest expert views and predictions about commodities: A 1970's style global commodity shock; the energy services sector; preferred ASX energy stocks; energy security and the surge in US natural gas prices.

-Citi expects a 1970’s style global commodity shock
-Benefits of exposure to energy services
-Preferred ASX stocks for a global energy crisis
-The need for energy security
-Why US natural gas prices are surging

By Mark Woodruff

Commodity shock as large as the 1970’s oil shock?

The ongoing global commodity shock is set to become as large as the first oil shock almost 50 years ago, according to Citi.

There was a 237% rise in nominal value of commodities consumed over 1970-74 during the first oil shock, compared to the 101% increase from 2019-2022 (Citi estimate). However, nominal GDP rose by 79% in the early seventies compared to 8% for the latter period, leaving the change in the value of commodities consumed as a share of nominal GDP broadly the same for the two periods, explains the broker.

A negative impact on consumption will likely occur, according to Citi, even though the shock to commodity consumers is by definition equal to the gains for producers. This is because the latter generally have a higher savings rate.

The longer the shock persists, the bigger the negative impact on the consumer, equities and global growth, with Europe and emerging markets considered particularly vulnerable.

Commodity-driven inflation is cutting real disposable incomes of European households by -2% annually, Citi calculates. It’s estimated two thirds of this shortfall is being funded via household savings made during the pandemic, while governments are compensating for the balance.

To counter the combination of higher inflation, weaker growth and higher interest rates, Citi advises oil and mining stocks are the best hedge. Elsewhere, weaker growth is expected to impact cyclical stocks, while expensive growth stocks should suffer due to higher interest rates.

In common with the 1970s, there are fundamental dislocations in the oil market, explain the analysts, that are pushing prices well above where supply versus demand balances might justify.

This disparity in pricing versus supply/demand explains why the broker expects prices to trend downwards in the second half of this year. It’s estimated global oil balances will remain in decent surplus, as was mostly the case in the second quarter of 2022.

The net loss of Russian oil will likely be at more manageable levels than feared, due to a range of factors including the slow embargo phase-in and the substitution effects for different crude grades by certain countries, explains Citi. In addition, supply increases are expected from other key regions, while the demand for gasoline and distillate fuel are showing signs of exhaustion.

Benefits of exposure to energy services

Taking a more alarmist view than Citi, UK bank Barclays forecasts a larger and more sustained disruption in Russian oil supplies, following the announcement of fresh EU sanctions. Sanctions will also be targeting shipping insurance for exports to other destinations.

This disruption, along with ongoing disruptions in Libya, is likely to more than offset softer demand growth and slightly higher US production, estimates Barclays. Hence, a normalisation of inventories over the forecast period is no longer expected, and Brent price forecasts are raised for 2022 and 2023.

Barclays suggests current conditions in the oil and gas industry are similar to the ‘super-cycle’ of 2005. That was the first year of a multi-year upturn that saw upstream capital expenditure more than double by 2008. It’s thought the inability of recent investment levels to meet demand needs would have become apparent in time, even without the exacerbation provided by the current Russia/Ukraine crisis.

The bank explains oil companies take some time to react to short-term moves in the oil price with new capital expenditure plans, as budgets need to be rebased. For now, projects with short payback periods are expected to be accelerated, and longer-term budgets will increase after a few rounds of budget setting.

As spending plans of the operators start to move higher, the potential of stocks within the Energy Services sector should increasingly come into focus, explains Barclays, in this case referring to the UK. Many of these companies are also expected to benefit from contract wins in the renewables space, as the energy transition gains critical mass. 

Preferred sector exposures in a global energy crisis

Over the last nine months ASX-listed Energy listed stocks have outperformed the broader ASX200 by around 50%.

Barrenjoey suggests the world is facing a global energy crisis and expects higher energy prices for longer due to insufficient action to address several years of underinvestment, and limited means to return Russian energy into the supply mix.

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