Oil

Oil And Gas Stocks Are Popular Once Again

Oil pumpjacks in a desert landscape
Credit: Shutterstock photo

Funds that have spent years reducing their exposure to oil and gas stocks because of the ESG trend are now scrambling to get back in on the fossil fuel game. Reuters' David Randall wrote this week that allocations to energy stocks from fund managers gained 23 percentage points over the last month as energy stocks strongly outperformed the S&P 500, enjoying a 53.8-percent rise compared with 20.2 percent for the broader index.

According to Randall, the energy stock rally caught fund managers by surprise. This implies that many had believed that the ESG trend would strengthen and grow uninterrupted. There was good reason for that belief, too, as asset managers with trillions of dollars in assets and other large institutional investors commit to net-zero policies for them and their clients.

Yet, the harsh reality seems to be that there is still a future - and returns - in fossil fuels, especially as energy demand increases as the northern hemisphere moves closer to winter. The ongoing energy crunch has led to urgent revisions of oil and gas demand by various forecasters and even to calls for more investment in oil and gas production from parties including none other than the International Energy Agency, which earlier this year called for the immediate end of such investments to reach net-zero targets.

OPEC has also been calling for more investments in oil and gas to fill the gap between supply and demand. In the meantime, however, it has kept a lid on production, limiting supply and fueling the price rally. With this, it has once again established itself as the ultimate swing factor for oil prices as well as oil's role in the global energy mix for the foreseeable future.

"I have a sneaking suspicion that energy prices may be elevated for a while because it will take some time for the supply side to catch up," Jack Janasiewicz, portfolio strategist at Natixis Investment Managers, told Reuters' Randall.

Indeed, the catching-up part would be challenging because it, again, depends on OPEC and its willingness to boost production. U.S. producers could have stepped in and started pumping more, but it appears that their shareholders have other priorities, chief among them cash returns after years of fruitless anticipation as producers bet on uncontrolled production growth.

President Biden has called on the U.S. oil and gas industry to step in and fix the tight supply problem, but, according to industry insiders, companies are unlikely to heed the call after Biden came into office with a clearly anti-oil agenda, Reuters reported earlier this month.

With supply remaining tight, crude inventories are falling across the OECD and the U.S., adding to the upward potential of oil prices and boosting energy stocks further. And while there is some concern the rally will eventually end, this end is not exactly in sight yet, prompting fund managers to reverse their strategy from recent years.

Things might get even worse for oil bears. OPEC's spare production capacity is threatened by a substantial decline, from around 9 million bpd in the first quarter of this year to some 4 million bpd by the second quarter of 2022 as the cartel ramps up production to pre-pandemic levels, the IEA said in its latest monthly oil report.

Meanwhile, inflationary pressures are also supporting higher oil prices. There are some who still believe rising inflation is a temporary problem, but others are warier as reflected by the increased interest of funds in energy stocks and the increased buying on oil futures markets.

With persistent supply chain problems, labor shortages in the U.S., and the slim chance of energy demand beginning to ebb anytime soon, inflation is likely to hang around for a while, stimulating higher oil and gas prices, and rewarding the stocks of the companies that produce them, despite the popularity of ESG investing trends.

By Irina Slav for Oilprice.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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