After a decade of disappointment, 2021 was the year when energy finally bounced back and outperformed the broader market. Crude, recovering from the shock of the pandemic's early days and massive oversupply, spent most of the year tracking upwards, bringing energy stocks along for the ride. XLE, long the poor relation amongst the sector ETFs, was a top performer, and even the moribund big oil stocks and battered shale producers soared.
So, what are the chances of a repeat in 2022?
Unfortunately, I would say they are slim, at least in the early part of the year.
As always, the price of oil will be the deciding factor in the performance of the sector and, despite a good start to the year in that regard, it is hard to be particularly bullish for the foreseeable future. The boost over the last few days has come mainly from the disruption in Kazakhstan threatening output there and despite, not because of, economic conditions and other supply factors.
That situation is significant, of course, but I find it hard to believe that the disruption will last. Kazakhstan is very dependent on oil revenue and whoever ends up in power, it will be important to turn the cash faucet back on as soon as possible. The importance of oil revenue to smaller producing countries is why these localized crises rarely have a lasting impact. If a country's output is big enough to move the price of oil when it is threatened, then it is big enough to make restoring it a major priority…
After a decade of disappointment, 2021 was the year when energy finally bounced back and outperformed the broader market. Crude, recovering from the shock of the pandemic's early days and massive oversupply, spent most of the year tracking upwards, bringing energy stocks along for the ride. XLE, long the poor relation amongst the sector ETFs, was a top performer, and even the moribund big oil stocks and battered shale producers soared.
So, what are the chances of a repeat in 2022?
Unfortunately, I would say they are slim, at least in the early part of the year.
As always, the price of oil will be the deciding factor in the performance of the sector and, despite a good start to the year in that regard, it is hard to be particularly bullish for the foreseeable future. The boost over the last few days has come mainly from the disruption in Kazakhstan threatening output there and despite, not because of, economic conditions and other supply factors.
That situation is significant, of course, but I find it hard to believe that the disruption will last. Kazakhstan is very dependent on oil revenue and whoever ends up in power, it will be important to turn the cash faucet back on as soon as possible. The importance of oil revenue to smaller producing countries is why these localized crises rarely have a lasting impact. If a country's output is big enough to move the price of oil when it is threatened, then it is big enough to make restoring it a major priority under any circumstances.
As that short-term bullish impact inevitably fades, the focus of the market will return to the bigger supply picture and the prospects for demand strength in the first half of the year. Neither gives cause for optimism on oil prices.
From the supply side, OPEC+ is so far sticking to its planned output increases, which means that at some point before too long more oil will be hitting the market from those countries. And that could well come at the same time as free market supply also starts to ramp up. Several producers have announced plans to start increasing capex spending this year from the drastically cut present levels, so supply generally will likely be increasing over the next few months.
That is all well and good, providing that demand recovers back to pre-pandemic levels or higher, but that is far from certain.
The latest variant of COVID, Omicron, may not be too much of a big deal in some ways. As I can personally attest having caught it over the holidays despite being triple vaccinated, it is highly contagious, but symptoms are generally quite mild, so there is little to no risk of it prompting widespread shutdowns. What it does, though is to highlight the risks going forward. As long as a significant percentage of people remain unvaccinated, there will be other variants, and a lot more 5-day isolation periods when people aren't driving or flying.
This is also the year when the Fed has told us they will be pivoting to tighter monetary policy. For now, that means just decreasing asset purchases, but before long it will mean interest rate hikes. Rate hikes have a dampening impact on growth by design, so traders will start to price in some expected slowing before too long as well.
As a result of all that, the baseline demand for fuel, and therefore crude, could well be lower for a while to come, and you don't have to be Milton Friedman to know what that means for price as that situation meets rising supply.
Then there is politics…
As I said in my 2021 review, those that believed the partisan take on Joe Biden, that he would decimate the oil industry, that was around at the start of last year got it completely wrong, but a year has changed a lot and some restrictions and regulation of the oil business this year would come as no surprise.
Last year, Biden was newly elected, with majorities, albeit slim ones, in both the House and Senate. He could set priorities himself and not give in to any faction. Now, though, with his agenda failing and his popularity down, he needs to ensure the support of the Left of his party, and that means more rhetoric, or maybe even more action, against big oil.
So, oil faces a start to the year where there is increasing supply on two fronts, questions about demand growth, also on two fronts, and the possibility of a hostile regulatory and legislative environment. I would love to say that 2022 will be more good news for the energy sector but, with those hills to climb early in the year, it looks more likely that we will see a return to underperformance this year.
Comments