Crude oil is trading near a 10-month high at $95 a barrel. Brent crude oil, the global benchmark, has gained roughly 30% since June.
West Texas Intermediate (WTI), the U.S. benchmark, is on pace for its fourth consecutive weekly gain, and is up about 27% this quarter, pushing gasoline prices to an 11-month high.
And we’re just getting started…
In addition, the price of diesel has soared even faster, especially in Europe. Distillates such as diesel, gasoil, and heating oil are the primary fuels used by the industrial economy. Inventories were severely depleted in August—U.S. distillate fuel oil inventories were 23 million barrels, or 16% below the prior ten-year seasonal average in August. The deficit to the prior ten-year average has widened since March and April, putting strong upward pressure on prices.
The rising price of oil is also hitting the financial markets. The S&P 500 is down about 3% since hitting a high in July, as investors fear energy prices could re-accelerate inflation and stifle growth. The sell-off has been even more acute in the bond market, with the yield on the 10-year Treasury on Tuesday hitting a high not seen since 2007.
Why Oil Is Rising Again
There are two reasons for the recent jump in oil prices: first, Saudi Arabia and Russia extended production cuts to the end of the year, removing more than a million barrels a day from the market. This will likely leave the global oil markets short about three million barrels a day in the fourth quarter.
The second reason is a resilient global economy. Demand—particularly from China—remains robust. This is happening despite Wall Street telling everyone how a recession is just around the corner.
Despite fears about economic weakness in China, its crude oil imports rose to 11.5 million barrels per day in August, according to Rystad Energy—two million barrels a day higher than this time last year!
That sort of leap leaves this year’s forecast world demand growth for oil looking too conservative. The International Energy Agency forecast put oil demand growth for 2023 at 2.2 million barrels a day.
Let’s take a closer look at some specific numbers for oil, from an article by Reuters John Kemp. Kemp reports that those extra production cuts announced by Saudi Arabia and Russia will have removed a total of 125 million barrels of crude from the market by the end of September and 245 million by the end of December, if implemented in full.
Meanwhile, the economic outlook here in the U.S. has improved. We have faster growth, a lull in inflation and the prospect the Fed will pause its campaign of interest rate rises.
Less oil being produced and greater consumption have combined to transform the outlook for inventories, prices and calendar spreads. Here’s the data from Kemp:
● U.S. commercial crude inventories have fallen in seven of the most recent ten weeks, by a total of 32 million barrels since the end of June.
● Front-month Brent futures prices have averaged more than $91 per barrel, up from $75 in June, after adjusting for inflation.
● Brent’s six-month calendar spread has tightened into a backwardation averaging $4.50 per barrel in September from $1.33 in June. Backwardation occurs when the spot price is higher than the upcoming futures prices.
And make no mistake—the months-long rally that has sent prices close to $100 a barrel is far from over.
Kemp wrote: “In real terms, monthly prices would have to average $110 per barrel to be in the 75th percentile for all months since 2000, and $146 to reach the 90th percentile. From a producer perspective, real prices are not very high yet, and there may be scope to raise them further without a negative impact on consumption and revenues.”
It looks like the good times are back in the oil industry. So where are the best bargains among the oil companies?
European Oil Giants Are Cheap
Saudi production cuts have wrongfooted the analysts again.
Analysts expect earnings at the major European oil producers to have fallen 23% in 2023 and to fall a further 6% in 2024, according to Bernstein Research. These earnings estimates should be revised upward soon—and with those rising earnings estimates will be the stock prices of the European majors.
The sector’s forward earnings multiple of 7.4 times, despite record cash flow yields, is almost laughably low. And many of these companies pay a decent dividend as well.
Here are three European oil stocks to consider:
Shell PLC (SHEL): up 24% over the past year and 15% year-to-date. It is trading at a 52-week high, with a yield of 4.32%.
TotalEnergies SE (TTE): up 35% over the past year and 6.7% year-to-date. It is trading at a 52-week high, with a yield of 5.69%.
Eni SpA (E): up 47.8% over the past year and 14.25% year-to-date. It is trading at a 52-week high, with a yield of 6%.
The stocks of all of these European oil companies have a lot of catching up to do, just to get to a reasonable valuation. They are all buys at their current prices.
