- Russia’s energy exports had initially been spared from sanctions by US, but this has since changed. On 8 March 2022, President Biden signed an Executive Order to ban the import of Russian oil, liquefied natural gas, and coal to the US.
US is likely able to stomach this ban because of their strong domestic energy infrastructure. Europe however, may find such a ban especially challenging, given their reliance on Russia’s energy exports. Nevertheless, as tensions further escalate, we anticipate more of such sanctions to come.
While the world remains transfixed by how the Russia-Ukraine conflict has pushed up oil prices, we think that oil prices would have rallied even without this event.
The oil market was tight even before Russia invaded Ukraine. Years of under-investment in the sector, coupled with OPEC+’s reluctance and inability to increase oil supply, means that there are likely no buffers against high oil prices.
Moreover, with oil being a major beneficiary of a continued economic reopening over the course of 2022, oil prices could reach USD 150 per barrel.
Investors can consider the Blackrock World Energy Fund A2 USD to get exposure to the booming oil and gas industry. The fund is involved in the exploration, development, production and distribution of energy, and is poised to benefit from the rising energy prices.
Alternatively, they may consider the JPMorgan Funds - Global Natural Resources A (acc) USD which invests in natural resource companies, such as those involved in oil and gas exploration and production, as well as in metals and mining.
Global commodity markets have surged to record highs, with oil prices surging past USD 100 a barrel, the highest level since 2014, after Russia’s invasion of Ukraine (Figure 1). Sanctions against Russia continue to mount, raising the likelihood of a major global supply disruption.
Going forward, we expect oil prices to remain elevated, given that it is a major beneficiary of the continued reopening of economies over the course of 2022. Moreover, amidst many supply-chain disruptions, we think that oil prices could reach USD 150 per barrel.
Figure 1: WTI Crude Oil spot price
Ban of Russia's crude imports adds to supply shortage fears
Russia’s invasion has severe implications because the country is resource-rich. Russia is the world’s second-largest oil producer, and supplies over 40% of Europe's natural gas supplies, and more than 25% of its crude oil.
In view of Russia’s actions against Ukraine, the path towards a de-escalation of conflict becomes increasingly challenging. While the US and its allies had initially stopped short of imposing sanctions directly on Russian oil and gas, this has swiftly changed.
On 8 March 2022, President Biden signed an Executive Order (E.O.) to ban the import of Russian oil, liquefied natural gas, and coal to the US. The order also bars new US investment in Russia’s energy sector and blocks Americans from financing companies that invest in the sector.
With this ban in place, US is trying to ramp up shale oil production to replace Russia oil. However, according to Bloomberg, US producers such as Pioneer and Devon Energy will take months to ramp up production in order to replace the 700,000 barrels per day of Russia oil and product imports banned by the Biden administration. As on average, there has been a six month lag between the start of drilling and first oil production in the Permian (largest petroleum-producing basin in the US).
Where it stands, US is still likely able to stomach this ban due to their strong domestic energy infrastructure, but Europe may find such a ban especially challenging, given their reliance on Russia’s energy exports. Nevertheless, as tensions further escalate, we anticipate more of such sanctions to come.
Moreover, for the first time since the invasion of Ukraine, Russia has threatened to weaponise its energy exports by cutting natural gas supplies to Europe via the Nord Stream 1 pipeline, in response to sanctions imposed. As such, this move could heighten the turmoil in energy markets and drive oil prices even higher.
The Russia-Ukraine crisis is just a piece of the puzzle
While the world remains fixated on how the current Russia-Ukraine conflict is pushing up oil prices, we think that oil prices would have rallied even without this event. This is especially because the demand-supply imbalance within the oil markets is an issue that has been brewing for quite some time.
As following an abysmal 2020, the oil market staged an impressive recovery. Global economies started to reopen and recover, travel started to pick up, and oil rebounded from its pandemic lows (Figure 2).
Figure 2: Global oil demand rebounded from the pandemic
But despite the recovery in oil demand, oil supplies remained tight. This is unsurprising, given that the oil and gas industry has been one of the most disliked, and out-of-favor sectors in recent years. Environmental, Social, and Governance (ESG) mandates to restrict capital to the industry posed major challenges for a sector that badly needed new investments to keep up with the growing demand.
The result is that annual investment in upstream oil and gas peaked at USD 780 billion in 2014. Since then, the highest annual spending seen was in 2019, which amounted to USD 483 billion, just 62% of 2014 levels (Figure 3). In 2021, annual investment in upstream oil and gas amounted to only USD 351 billion, despite the fact that the world is still highly reliant on these fossil fuels – makes up 80% global energy needs.
Figure 3: Falling investment into oil and gas industry
Without an increase in oil supplies, the vast oil surplus accumulated during the first few months of the pandemic has been wiped out, with inventories of OECD countries falling (Figure 4).
Figure 4: Declining crude oil inventories
Going forward, weak supply from OPEC+ will further aggravate this demand-supply imbalance. While the United Arab Emirates had appeared to push members of OPEC+ to raise output, the Gulf state remained committed to the existing monthly output agreement.
OPEC+ is unlikely stray from its current deal and is sticking to existing policies of moderate output increases of 400,000 barrels per day – an incremental amount that has done nothing to calm prices. This comes after having reported that several OPEC+ members have struggled to pump even in line with their quotas (Figure 5) due to years of under-investments or large maintenance work that has been delayed by the Covid-19 pandemic.
Figure 5: Production by OPEC+ group has been well below target since the summer
Why oil could hit USD 150 per barrel
Looking at the situation now, it shares some similarities to what has happen in oil markets back in 2008, when oil prices shot up from USD 90 a barrel in January to a record high of USD 147 a barrel on 11 July 2008.
Back then, the demand for oil was growing rapidly, especially amongst developing economies such as China and India. Moreover, weakness in the US dollar and geopolitical tensions such as an Israeli attack on Iran in June 2008 caused a huge spike in oil prices.
Similarly, Russian troops were also preparing to invade another former Soviet republic — Georgia back then. Western countries were imploring OPEC members to open the taps in view of high oil prices. Although OPEC members responded by increasing their production, they lacked sufficient capacity after years of restrained field investments to bridge the demand-supply gap. The result was that crude oil price eventually hit an all-time high of nearly USD 150 a barrel.
While there are obvious differences between the events happening today compared to 2008, the economic principles enumerated back then still applies today. And fast-forward to today, many analysts think that USD 150 oil per barrel is not out of the question.
Key investment risk
Demand destruction and volatility: Seeing that supply in oil markets is expected to remain tight, the biggest downside risk for oil markets at this moment stems from demand destruction. A demand destruction may come from an economic slowdown that could stem from the current geopolitical conflict and sanctions, as well as the elevated energy prices, which may cause people to cut back on consumption.
Additionally, the resurgence of Covid-19 cases and subsequent lock-downs is a risk to take note off. China’s the world’s largest crude importer is faced with a latest virus outbreak, with growing clusters in some of its most developed cities. With its zero Covid policy, and subsequent lockdowns, it could slow the demand for oil.
As such, we expect to see much volatility within this sector. The nature of the commodities sector is that it goes through various boom/bust cycles. This means that while price changes can hit extremes to the upside, it can similarly hit these extremes to the downside, albeit with usually long spans between these two extremes.
Higher for longer oil prices
The war in Ukraine and the resultant mayhem in global energy markets underscores the global nature of oil supply and trade, and the insufficient investment in oil and gas sector in recent years. However, even if the conflict in Ukraine ends and sanctions are lifted, crude oil prices will still likely remain elevated. Fundamental improvement in supply capacity is likely to take some time. Meanwhile as economies reopen following the Covid-19 pandemic, demand for oil is likely to remain robust.
As such, investors may wish to consider the Blackrock World Energy Fund A2 USD, if they are seeking a dedicated energy fund, which is involved in the exploration, development, production and distribution of energy.
The fund has exposure to integrated players with an emphasis on production, such as Chevron Corporation (NYSE:CVX), Shell PLC (NYSE:SHEL), and Exxon Mobil Corporation (NYSE:XOM), which are well-poised to benefit from higher oil and natural gas prices (Table 1). Moreover, these oil majors have a breakeven oil price in the 40s in 2021, meaning that they remain highly profitable at current price levels. The Blackrock World Energy Fund also does not have any geographical exposure to Russia (Figure 6).
Table 1: Top 10 holdings of the Blackrock World Energy Fund
|
Rank |
Holding Name |
Net Assets (%) |
|
1 |
Chevron Corporation |
9.98 |
|
2 |
Shell PLC |
9.55 |
|
3 |
TotalEnergies SE |
7.66 |
|
4 |
ConocoPhillips |
6.16 |
|
5 |
TC Energy Corporation |
4.79 |
|
6 |
Pioneer Natural Resources Company |
4.77 |
|
7 |
EOG Resources Inc |
4.73 |
|
8 |
Exxon Mobil Corporation |
4.71 |
|
9 |
Marathon Petroleum Corporation |
4.34 |
|
10 |
Williams Companies Inc |
4.26 |
|
Source: Blackrock World Energy Fund, iFAST Compilations Data as of 28 Feb 2022 |
||
Figure 6: Geographical exposure of the Blackrock World Energy Fund
Furthermore, given that the commodity markets are booming, investors can similarly consider the JPMorgan Funds - Global Natural Resources A (acc) USD Fund, which invests in natural resource companies, such as those involved in oil and gas exploration and production, as well as in metals and mining.
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