Diana T. from El Paso, TX asks: Hello Mitch, I wondered if you had any thoughts about a big rebound in energy this year. My husband and I work in the oil and gas industry and feel like it could be a good year.
Mitch’s Response:
Thanks for writing, Diana. Generally speaking, I share your outlook about the energy sector, and in particular oil and gas. Three factors drive my views: supply, demand, and mean reversion. I’ll explain each one below.
Let’s start with supply. In the years leading up to the pandemic, there was a notable supply glut in crude oil. The shale boom drove stockpiles higher, and when the pandemic hit, inventories ballooned – putting intense downward pressure on prices. Since you work in the oil and gas industry, you probably remember the moment when oil futures turned negative, on the heels of extreme uncertainty. You can see the plunge in the chart below.
Source: Federal Reserve Bank of St. Louis1
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The supply situation looks better today. Stockpiles are shrinking, and the Organization for Petroleum Exporting Countries (OPEC) continues holding back millions of barrels a day from the market. These dynamics support upward pressure on crude oil prices.
Next is demand, which was obviously sapped during the global economic lockdown and all the restrictions that followed (and continue today). An economic recovery bodes well for the energy markets, and there’s a good argument we’re still in the early phases of said recovery. As vaccine uptake improves and the world moves past the pandemic, I expect demand to firm up even more.
In the current environment, the winter storms engulfing much of the United States also raises demand for oil and gas. According to the National Weather Service, over 150 million Americans are under a winter advisory of some type. Natural gas prices are very sensitive to extreme weather events, and we’ve seen prices move higher as a result.3
The final factor driving my positive outlook for energy is mean reversion. Energy has been battered down in recent years as other areas of the market have rallied, and I think high valuations in many parts of the market will nudge investors to rotate from high valuation to low valuation. Energy is the most obvious sector for some of this capital to rotate.
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Disclosure
2 ZIM may amend or rescind the free guide offer, Using Market Volatility to Your Advantage, for any reason and at ZIM’s discretion
3 Wall Street Journal. February 15, 2021. https://www.wsj.com/articles/oil-prices-reach-fresh-highs-as-cold-blast-hits-texas-11613394038?mod=hp_lead_pos4
4 ZIM may amend or rescind the free guide offer, Using Market Volatility to Your Advantage, for any reason and at ZIM’s discretion
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