Will recession and inflation fears derail oil bull market?

Pre-eminent energy analyst assesses prevailing long-term supply and demand picture

Will recession and inflation fears derail oil bull market?

Over the past year, energy has been a breakout sector within the financial markets, shooting past the $100 per barrel mark as supply issues, Russian sanctions, and the resurgence of demand post-COVID create a perfect storm for commodities. But more in recent weeks, that excitement has worn off as inflation and recession fears give way to a softening of oil prices and a selloff in energy stocks.

While many may be wringing their hands and expecting an end to the energy bull market, Amrita Sen, founder and Director of Research at Energy Aspects, holds a different view.

In a recent webinar hosted by Ninepoint Partners, Sen asserted that oil’s price growth story is a more long-term, structural one that rests on steadily growing energy demand and chronic underinvestment in production capacity.

Looking back in history up to the 1970s, she said oil demand has declined only four times: twice in the ‘70s, during the Arab oil embargo and in the aftermath of the Iranian Revolution; once in 2008-2009, the great financial crisis; and again in 2020, when demand for oil collapsed as the COVID pandemic entered the global scene.

“In April 2020, during COVID, 97% of global industrial production was shut. None of us were traveling,” Sen said. “Yet oil demand only fell by 20%, about 20 million barrels per day, to 80 million barrels per day.”

Other than those periods of decline, she said, the world’s thirst for oil has managed to rise even in the face of the ’97 Asian economic crisis, the early 2000s dot-com bubble, and the gloomy years of 2011-2014 in Europe. She estimated that every year, demand has always grown by more than a million barrels per day.

On the supply side, Sen projected that by the end of this year, OPEC’s production capacity will represent less than 1% of global oil demand. That number is short of the 5% buffer she suggested is necessary to safely account for outages that tend to occur in politically unstable oil-producing regions.

“We called for $100-plus oil prices between 2023 and 2026, pretty much from 2018 onwards,” she said. “That was absolutely based on underinvestment [in oil producing capacity].”

While lulls in oil production investment usually occur in four- or five-year cycles, she says the current drought in capital investment has been going on for eight years. That has come as a result of numerous disruptive developments over the past decade including the shale boom, an increased focus on climate concerns and ESG, and the COVID pandemic.

With oil prices where they are, now might be a good time for energy producers to consider investing in more wells and rigs. But based on conversations she’s had with industry leaders, Sen said efforts are hampered by an inability to find workers and massive delays in steel delivery. Beyond that, there’s the growing practice of tying CEO renumeration in the industry to ESG metrics.

“We are putting in about $400 billion right now in upstream capex, of which at least $25 billion to $30 billion is actually increasingly going to green energy,” she said, adding that an estimated 15% to 20% of capex increases in the energy sector is getting lost to cost inflation. “Based on our calculations, we need a minimum of $520 billion to hold production flat at 100 million barrels per day.”

National oil companies like Saudi Aramco are starting to step up with new projects, she said, but those aren’t expected to be fully online until 2027. By then, oil producers will have to service a substantially higher level of energy demand as global economic growth continues. Meanwhile, investments in alternative energy are far short of what’s needed to make up the difference.

“Ultimately, the trajectory and the only balancing mechanism has to be that prices have to go up to a point and stay there for a while for demand to really get destroyed. And I don’t use that term lightly,” Sen said. “But that takes a long time.”