Fuel-Shortage Risks Make Investors Bullish on Energy Stocks

Energy stocks and bonds are poised to get a fresh boost from investors positioning to benefit from the surging electricity 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 exposure to the sector over the next six months. They see electricity and natural gas prices driving global inflation and expect that Russia will choke off flows of natural gas to Europe, leading to shortages of key fuels this winter.

Energy stocks are one of the rare bright spots in the world’s equity markets, with an index of energy companies in the S&P 500 rallying by more than 40 percent so far this year as profits surged along with oil and gas prices. Yet they remain significantly cheaper than their S&P 500 peers based on their prices relative to the earnings they’re expected to report in the year ahead. While junk-rated energy bonds are expensive compared with the global index, the U.S. energy debt rated at investment grade BBB is relatively attractive, trading at a higher spread than the average of its peers by rating and duration.

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

Energy markets have come under further strain as Russia constricts deliveries of natural gas through its Nord Stream pipeline, causing prices in Europe to almost triple this year. European Union (EU) sanctions are set to squeeze Russian oil supplies when they take effect in December.

Europe’s worst energy crisis in five decades is making rationing look all but inevitable this winter. The EU has already created a voluntary 15 percent demand-reduction target for gas, with the option of making it obligatory if needed, and warned of “further drastic reductions” if temperatures are especially low.

Almost three-quarters of the MLIV Pulse survey’s 814 respondents expect electricity and natural gas prices to drive global inflation the most this winter. A similar majority said that if there will be any shortages over the next six months, it will be of key fuels, including natural gas.

Years of under-investment during the attempt to transition away from the fossil fuels have left global supplies unable to satisfy 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’re solving the energy problem in the long run is through investment—and oil companies are the conduit for the capex [capital expenditures] to solve the problem.”

The surge in energy prices has hit major economies with a brutal wave of inflation, which has reached record levels in the Eurozone and the hottest pace in almost four decades in the United States. Goldman Sachs has warned that inflation in the U.K. could top 22 percent next year if natural-gas prices remain elevated. Economists increasingly predict a Eurozone recession in the coming quarters, as the rising cost of living saps demand, undermining the pandemic rebound.

“It’s not only commodities that will drive up inflation, but also government reaction to high prices of commodities,” said Anna Mikulska, a non-resident fellow in energy at Rice University’s Baker Institute for Public Policy. “The negative effect of pumping more money into the economy will be inflation, and artificially lowering energy prices will lead to higher demand and higher prices.”

“The European gas market is likely to remain tight throughout the 2020s,” said Katja Yafimava, a senior research fellow at Oxford Institute for Energy Studies. The “global shortage of gas, hesitancy about new investment in new gas production,” and the EU’s “political decision to phase out its dependence on Russian gas altogether” are driving the tightness.

Nonetheless, bullish investors may have their nerves tested in the months ahead as the inflationary wave batters the global economy. Demand in China, the world’s second-biggest consumer, remains overshadowed by the property crisis and virus restrictions.

In the oil market, there are already signs of demand destruction taking place, with crude prices retreating by about 24 percent over the past three months. Most survey respondents expect oil prices to remain between $70 and this year’s peak of $139, with only 10 percent seeing crude surging above that level. About 46 percent expect energy crisis to accelerate the pace of green power generation. The global benchmark Brent futures rose more than 1 percent on Monday, approaching $94 a barrel as of 6:50 a.m. New York time.

Energy price volatility is itself posing a risk to the financial system, with the rising prices forcing utilities to put up more collateral for fuel-delivery contracts purchased with loans. Norwegian energy company Equinor ASA warned that margin calls of at least $1.5 trillion are straining energy trading and pushing governments to provide greater liquidity buffers.

Yet energy bulls are unperturbed. Even if a global economic slowdown causes oil prices to falter, they see another line of defense in the OPEC+ producers’ cartel led by Saudi Arabia. The alliance demonstrated its readiness to intervene by announcing a symbolic production cutback earlier this month.

The kingdom and its partners are likely to either hold production steady or cut it, rather than increase it, over the next six months, according to the survey. Some 44 percent of respondents believe that oil prices are failing to 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 year-end,” said Amrita Sen, chief oil analyst at consultant Energy Aspects. “OPEC+ has provided a price put, which should serve as a clear reminder that they will stop stockpiles from building should the world economy slump into a severe recession.”

The appetite for energy stocks appears to be sector-specific, as the majority of respondents said they will keep their exposure to the S&P 500 the same over the next month. IT and communication services shares, which have under-performed this year, are sensitive to economic slowdowns. Meanwhile, stocks of financial services companies, heading for their worst year since 2018, have been taking their cues from the Federal Reserve as it steps up its monetary tightening regiment to tame inflation.

—With assistance from Heather Burke, Sebastian Boyd & Tomoko Yamazaki.

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