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Oil stocks: liquidity-fuelled rally will not last

With the liquidity punch bowl overflowing, even the wallflowers at the party can get a dance. Oil stocks have all rallied sharply in price this year, leaving the broader market behind. A Brent price surge has helped. But, truthfully, business as usual is not a realistic scenario for the energy sector.

Producers Royal Dutch Shell and BP have reported earnings this week. Shell’s better than expected first-quarter results relied on better commodity prices. Its cash flow depends heavily on its oil and natural gas production.

On its own figures, crude prices jumped 48 per cent just compared with the fourth period alone. That, plus some asset sales, pushed net debt down to $71.3bn, about 4 per cent below the beginning of last year. Market enthusiasm was muted, as with BP’s even better figures on Tuesday.

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That is partly because no powerful recovery in oil demand has materialised. In the largest markets, US and China, petrol demand has not exactly surged ahead. True, China reports more traffic congestion but that is at odds with Beijing’s touting of climate change credentials.

In the US, people have taken to the roads too. But demand — as of April — remains 5 per cent below pre-pandemic levels, according to the US Energy Information Administration. India, another important oil consumer, is grappling with its worst increase in Covid-19 cases yet.

Cyclical shares have rallied, anticipating a mismatch of consumer demand with industrial capacity. For oil, that looks like the party punch talking, given central bank laxity on rates.

Too much has changed for the energy sector. Most portfolio managers today cannot easily square holding lots of oil stocks with the demands of clients keen to address climate change. This year, the EU’s Sustainable Finance Disclosure Regulation will put pressure on European fund managers to back up their promises on responsible investing.

Resurgent oil stocks may look cheap, given that forward price/earnings multiples are historically low. But do not chase markets dancing a 1920s-style Charleston. The world will sober up soon enough on oil stocks.

The Lex team is interested in hearing more from readers. Please tell us what you think of oil stocks in the comments section below.

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