Why Oil Prices Will Continue To Rally In 2021

Oil is at multiyear highs as it hovers around $75. Despite these gains, there is more upside as demand is strong, and companies are not increasing production or investing in new supply.

Like many assets, oil has had a stunning turnaround since the depths of the coronavirus. In April 2020 the front-month contract actually went negative as many traders were forced to sell at a loss to avoid taking delivery. Of course, demand was also collapsing due to the coronavirus, shutdowns, and restrictions in mobility in many parts of the world. It resulted in record inventories, and companies paying exorbitant amounts of money to store oil on tankers.

A little more than a year later, the situation is quite different, as oil prices are at multi-year highs with the front-month contract reaching $75 per barrel. This is evident with the United States Oil Fund (USO) which is up 193% from its lows during last spring. 

Inventories have been drawn down, while demand is nearly at pre-pandemic levels, despite continued COVID-19 restrictions in many parts of the world. If things continue to normalize and travel volumes continue improving, then demand is likely to continue growing. While demand has rebounded, supply has not rebounded. In fact, CAPEX in the energy sector has been low for many years due to the impact of shale production over the last decade. Based on the lack of new production and supply constraints, I believe that oil prices could reach new highs in the coming years. 

Supply Situation

Even though oil has had a healthy recovery, there is some skepticism that the rally will continue. This is evident from future-month contracts which are trading at a discount to front-month contracts. This is also reflected in the multiples of energy exploration and production companies which are trading at low multiples that only make sense if one expects energy prices to reverse lower.

It’s clear that many companies also believe in this narrative as CAPEX has not risen. In fact, over the past decade, energy prices have trended lower in part due to the massive supply that was unleashed following the previous bull market. Thus, management teams that have prioritized cash flow and reducing leverage have been rewarded, while those who aggressively invested in increasing capacity were punished. This is clear in the chart below-showing capital spending from oil & gas companies over the past decade.

1 2
View single page >> |

Disclaimer: Information is provided 'as-is' and solely for informational purposes, not for trading purposes or advice, and is delayed. To see all exchange delays and terms of use, please ...

more
How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.