by Bryan Perry

May 17, 2022

The Russia/Ukraine war can’t be overlooked. It is having a major impact on the global supply of fossil fuels. The sanctions and widening embargo against Russian oil exports is the equivalent of losing Saudi Arabia or the U.S. in terms of production. The embargo on a major oil supplier like Russia as a source to the global oil market can’t be replaced or made up, meaning the loss of access to Russian oil and refined products puts the current market for supply in a bad place, and that is why crude prices are surging again.

West Texas Intermediate Crude Oil Price Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The emergence of the global economy from the widespread impact of the pandemic is resulting in a strong rebound in energy use in marine freight, rail freight, air freight, truck transport, more consumer driving, and more travel, so the situation with Russia now being offline is severely impacting the calculus of the global transport markets. At this juncture, there is no end to the supply shortage in sight. As Europe moves to a full embargo to include Hungary and all the members of the E.U., eastern European countries have to go to other global markets, of which there simply is not enough supply, to replace Russian oil.

The Biden administration is more behind the oil supply curve than the Fed is behind the inflation curve. Not until WTI crude hit $120 per barrel did President Biden announce the largest-ever release of oil from the Strategic Petroleum Reserve, set to supply the market with an additional one million barrels of oil per day for the next six months. The initial sale of 30 million barrels was hugely oversubscribed, with bids coming in for over 76 million barrels according to the U.S. Department of Energy. This bid-to-cover ratio of over 2.5x sent a strong signal to the market that dumping strategic reserves is only a temporary fix.

The oil futures market operates on three mechanisms – readily available supply, the outlook for future supply, and sentiment. To put this three-legged equation into perspective, the U.S. and the International Energy Agency are supplying the market with an extra 1-2 million barrels per day. It is estimated that the world uses 88 million barrels per day, and that’s without any major disruption in supply to the market.

This past week, the Biden administration canceled any new oil and gas lease sales to the Gulf of Mexico and Alaska, dealing a blow to future domestic production as gas prices hit new highs. There seems to be no end in sight to these constant political attacks on the U.S. oil and gas industry. The Biden administration and Congress are not managing their transition to renewable energy well at all, and as long as the government is going to be inhospitable to energy companies, energy prices will keep climbing.

The world’s economies need more fossil fuels, not just to satisfy current demand, but to avert a crisis that is already unfolding in Europe, with the growing potential of a supply crisis in the U.S. – as crazy as that might sound. American refiners are under long-term contracts to export vast amounts of refined gasoline, diesel, jet fuel, and lubricants that could result in rising deficits for these same products here at home.

Eighteen Month Average Retail Price Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

As for Saudi Arabia and other OPEC nations, they might bring another one million barrels per day to market, but the Saudis are not picking up the phone when Joe Biden calls. His lack of support in their conflict in Yemen and multiple legal suits brought against Crown Prince Mohamed bin Salman that include charges he ordered the murder of Jamal Khashoggi are a no-go for future increases in production.

Both China and India are buying the majority of Russian oil at a discount, enabling Russia to maintain some economic oxygen. It appears as if the only way to see any price relief in energy markets is if Vladimir Putin is removed from office. Such an event would likely trigger a $20-$30 sell-off in crude. As far-fetched as that seems, it looks to be the only major catalyst to reverse the solid uptrend for further increases in oil and gas prices. It is also fair to say that this desired scenario is not likely to play out.

Instead, investors seeking inflation-friendly growth and income for their portfolios should remain weighted in the energy sector. As WTI crude closed at $110 per barrel as of Friday’s close, the refining companies are in an even more profitable position, since the crack spread of what they pay for crude and what they sell refined products for is very wide. By comparison, the refiners are realizing profits as if they were oil-producing companies selling crude in a market where prices are $250 to $350 per barrel.

Standard and Poor's 500 Energy Sector ETF Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Back in early 2020, the energy sector, as represented by the Energy Select Sector SPDR ETF (XLE) ETF, accounted for only 2% weighting in the S&P 500. Today, it is closer to 10%, where it more than belongs. The chart of XLE is enviable and wildly bullish at a time when a greater share of S&P 500 stocks have bearish chart patterns. Based on the data I’ve read and the price action of the stocks within the energy sector, the path of least resistance for shares of energy stocks and ETFs looks solidly higher.

As they say, “Don’t fight the Fed,” and “Don’t fight the tape.” The Fed won’t be done tightening until mid-July at the earliest, and inflation will continue to be the albatross around the market’s neck. The good news is that there is a fierce bull market in the energy sector, where a few clicks of the mouse can do a lot of good, by selling stocks being punished by inflation and upping portfolio weightings in energy assets.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

Global Mail by Ivan Martchev
Stock Market Headed Between Scylla and Charybdis

Sector Spotlight by Jason Bodner
When Will the Selling End?

View Full Archive
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About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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