Earlier Monday afternoon, Brent crude oil prices, the global benchmark, jumped 7.5% to $42.40 and West Texas Intermediate (WTI) crude oil prices popped 8.3% to $40.20, as investors cheered positive vaccine results and an election victory for Joe Biden.
The stock market as a whole skyrocketed on news from drugmakers Pfizer and BioNTech that COVID-19 vaccine candidate BNT162b2 was more than 90% effective, compared with expectations for 60% to 70% effectiveness. Here’s why the vaccine news is good for energy stocks, and why oil prices could go higher.
1. There is increased demand for crude oil and refined products
The first and most obvious reason oil prices could continue to rise is higher demand. A return to a pre-pandemic way of life would likely lead to increased transportation, which accounts for the vast majority of oil consumption. Whether it’s someone commuting to work or driving to see an old friend or businesses having to restock shelves more often, a reopening of the economy means more gasoline consumption. It also means more diesel and natural gas consumption as industrial businesses begin to get closer to full production. And finally, it means higher demand for refined products that are used in virtually every industry.
2. Demand outpaces supply in the short term
Oil prices could continue to rise if demand outpaces supply in the short term. That dynamic could be set into action if the economy fully reopens while global production has fallen dramatically since U.S. crude oil prices went negative in late April. Small and large oil companies alike have curtailed production and plugged wells as a result of this oil downturn. Some of that production is coming back, but it’s still down substantially from 2019 levels.
For example, ExxonMobil implemented government-mandated reductions of 140,000 barrels of oil equivalent per day (boe/d) in the third quarter. After curtailing unconventional and heavy oil assets volumes in April, Exxon noted that those volumes were back to normal as of the end of September. Royal Dutch Shell said that upstream production was 14% lower in the third quarter compared with the same quarter last year and expects production to average 2.3 million to 2.5 million boe/d in the fourth quarter, higher than the third quarter but still below pre-pandemic levels. ConocoPhillips, one of the largest independent producers, expects fourth-quarter production to average 1.125 million to 1.165 million boe/d, down 14% from its 2019 average of 1.348 million boe/d.
In addition to curtailments from U.S. and European firms, OPEC+ has implemented a production cut of 7.7 million barrels per day (bpd), although it expects to reduce that number to 5.7 million bpd in January. According to secondary sources cited in its monthly oil markets report for October, OPEC produced 24.106 million bpd, down 17.8% from a 2019 average of 29.337 million.
3. Demand outpaces supply in the long term
Oil prices could climb if demand outpaces supply in the long term. This could happen for a number of reasons. Lower oil prices and weakening balance sheets pressured nearly every oil company to cut spending this year. Exxon, Shell, and ConocoPhillips made plans to cut their 2020 spending by 30%, 20%, and 35%, respectively, but actual levels could be higher. Lower spending reduces the development of proven reserves, the effects of which won’t be visible in the short term but could play a factor throughout 2021 and beyond.
Lower spending from producers also means less business for drilling contractors and oilfield services companies, many of which are struggling to make ends meet. Some of these oil companies could even go bankrupt unless prices go higher and stay higher, which could affect the supply chain and the response time needed to bring new production online. The following chart illustrates just how little drilling is going on.
The global rig count, which is a good indicator of oilfield activity, is down 50% this year and is at its lowest level in 10 years.
4. Companies turn to renewables
The final and most abstract argument that oil prices could go higher has to do with a shift in focus. Many European oil giants could turn into renewable energy stocks as companies such as Shell, Total, BP, and Equinor have expressed a firm interest in investing away from oil and into renewables that they believe could return favorable long-term profits. This change in sentiment, which was accelerated by the turmoil of the current downturn, could mean that these firms and others respond to higher prices by allocating extra cash toward alternative energy instead of ramping up production as they did in the past. And that circles back to oil supply not matching demand.
On track but uncertain
Many energy stocks surged by double digits on Monday, but there’s reason to be patient before jumping in right away. Even with the surge, WTI crude oil is still barely above $40 a barrel, a price where the best energy stocks can make a slight profit but the industry as a whole struggles. The economy seems on track to fully reopen, but until it happens there’s still a substantial amount of risk when it comes to investing in oil stocks.