Fuel shortage risks have investors bullish on energy stocks

Energy stocks and bonds are poised to receive further impetus from investors positioning themselves to benefit from soaring power prices and fuel shortages expected later this year.

Two-thirds of respondents to an MLIV Pulse survey, which includes portfolio managers and retail investors, plan to increase their exposure to the sector over the next six months. They see electricity and natural gas prices driving global inflation and expect Russia to choke off natural gas flows to Europe, leading to shortages of key fuels this winter.

Energy stocks are one of the few bright spots in global equity markets, with an index of S&P 500 energy companies soaring more than 40% so far this year as profits jumped alongside oil prices and gas. Still, they remain significantly cheaper than their S&P 500 peers, based on their price relative to the earnings they are expected to report over the coming year. While junk-rated energy bonds are expensive relative to the global index, US investment-grade BBB-rated energy debt is relatively attractive, trading at a higher spread than the average of its peers in terms of rating and duration.

“I definitely want to stay invested in energy stocks due to massive supply constraints,” Chris Wood, global head of equity strategy at Jefferies LLC, said in an interview with Bloomberg TV. “The other reason to own power is simply that you need a hedge against the growing risk of escalation in Ukraine.”

Energy markets are coming under increasing strain as Russia restricts natural gas deliveries through its Nord Stream pipeline, nearly tripling prices in Europe this year. European Union sanctions are expected to cut Russian oil supplies when they come into effect in December.

Europe’s worst energy crisis in five decades is making rationing all but inevitable this winter. The EU has already created a voluntary 15% gas demand reduction target, with the option to make it mandatory if necessary, and has warned of “further drastic cuts” if temperatures are particularly low.

Nearly three-quarters of the 814 respondents expect electricity and natural gas prices to be the main drivers of global inflation this winter. A similar majority said if there were to be any shortages over the next six months it would be key fuels, including natural gas.

Years of underinvestment during the attempted transition away from fossil fuels have left global supplies unable to meet the post-pandemic rebound in demand.

“It’s ultimately the revenge of the old economy: if you don’t invest in the old economy, it comes back to haunt you,” said Jeff Currie, head of commodities research at Goldman Sachs Group Inc. “The only way you are solving the energy problem in the long term is through investment – ​​and the oil companies are the channel for capital spending to solve the problem.

Soaring energy prices hit major economies with a wave of brutal inflation, which reached record highs in the eurozone and the highest pace in nearly four decades in the United States. Goldman Sachs has warned that inflation in the UK could exceed 22% next year if natural gas prices remain high. Economists are increasingly predicting a recession in the euro zone over the next few quarters as the rising cost of living undermines demand, undermining the rebound from the pandemic.

“The European gas market is expected to remain tight throughout the 2020s,” said Katja Yafimava, senior research fellow at the Oxford Institute for Energy Studies. The “global gas shortage, hesitancy over further investment in new gas production” and the “political decision by the EU to completely remove its dependence on Russian gas” are behind the sealing.

Nonetheless, optimistic investors may have their nerves tested in the coming months as the wave of inflation hits the global economy. Demand in China, the world’s second largest consumer, remains overshadowed by the housing crisis and virus restrictions.

In the oil market, there are already signs of demand destruction, with crude prices down about 25% in the past three months.

Most respondents expect oil prices to remain between $70 and this year’s high of $139, with only 10% seeing crude above that level. About 46% expect the energy crisis to accelerate the pace of green energy production.

Energy price volatility is itself a risk to the financial system, with rising prices forcing utilities to provide more collateral for fuel delivery contracts purchased with loans. Norwegian energy firm Equinor ASA has warned that margin calls of at least $1.5 trillion are weighing on energy trading and pushing governments to provide larger cash reserves.

Yet energetic bulls are undisturbed. Even if a global economic slowdown drives oil prices down, they see another line of defense in the Saudi-led OPEC+ producer cartel. The alliance demonstrated its willingness to intervene by announcing a token reduction in production earlier this month.

According to the survey, the kingdom and its partners are expected to either maintain production or reduce it rather than increase it over the next six months. Some 44% of respondents believe that oil prices do not reflect the realities of supply and demand, a disconnect recently identified by Saudi Energy Minister Prince Abdulaziz bin Salman.

“We continue to warn of significantly tighter markets at the end of the year,” said Amrita Sen, chief oil analyst at consultancy Energy Aspects. “OPEC+ has provided a price offer that should be a clear reminder that it will prevent stockpiling if the global economy collapses into a severe recession.”

The appetite for energy stocks appears to be sector-specific, as the majority of respondents said they would maintain exposure to the S&P 500 over the next month. Information technology and communication services stocks, which have underperformed this year, are sensitive to economic downturns. Meanwhile, those in financial services companies, heading for their worst year since 2018, are taking inspiration from the Federal Reserve as it steps up its monetary tightening regimen to tame inflation.

Reporting by Nour Al Ali and Grant Smith for Bloomberg News.

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