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What we expect from oil prices

Stocks still look cheap across all subsectors, especially oilfield services and refining, says Morningstar analyst Dave Meats.

Mentioned: Schlumberger Ltd (SLB), Valero Energy Corp (VLO)


David Meats: Widespread lockdowns are still depressing global crude consumption. A second wave of infections is still buffeting much of the Northern Hemisphere, especially Europe and the US, triggering more lockdowns and travel restrictions. But the market sees light at the end of the tunnel. A spate of successful vaccine trials followed by regulatory approvals and initial inoculations in some countries has sent stocks roaring higher.

Rystad Energy now expects 10.8 billion vaccine doses by the end of 2021, and in most developed countries, it thinks the vulnerable groups, the elderly and others at high risk, can be fully protected by March 2021. Beating the virus will enable governments to reopen borders and relax restrictions on gatherings and mobility, paving the way for near-complete recovery in crude demand.

But oil producers are not ready for the recovery yet. Without further investment, the current glut could become a shortage in late 2021 or 2022. OPEC-plus recently shied away from its original plan to bring back 2 million barrels per day of supply in January this year, and by late December, US shale firms had only reactivated about 90 rigs after mothballing more than 400 during the pandemic. The shale industry is attempting to shed its reputation for profligacy, and as a result, firms are allocating capital extremely cautiously. But collectively, they must bring back about 300 more rigs during 2021 just to maintain a comfortable supply deficit and prevent inventories from drawing down too quickly and perhaps collapsing below normal levels after the recent success.

So, higher crude prices are needed. Our midcycle forecast is still US$55 a barrel for WTI crude, and if that isn't enough of an incentive, we wouldn't rule out prices rising even higher in the short run. Higher prices bode well for energy stocks. The sector has dramatically outperformed the broader market since the Pfizer announcement on November 9, but the recent rally has not closed the gap with our valuations. Stocks still look cheap across all subsectors, especially oilfield services and refining. In those groups, our top picks are Schlumberger (SLB) and Valero (VLO), respectively.



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