Oil stocks went back in vogue two years ago with a vengeance as investors sought to get a piece of the record profits the industry reaped from the gas squeeze in Europe and the oil squeeze fears prompted by sanctions on Russia.
Two years on, and that appeal is dissipating, at least according to some banks, as oversupply in oil looms over the market, and demand growth remains below optimistic expectations. In fact, one bank believes European Big Oil is maxed out.
Last month, Morgan Stanley cut its price target for crude oil, citing rising supply and dwindling demand growth. The bank also cut its share price targets for the European Big Oil majors without exception. TotalEnergies, Shell, BP, Equinor, and Repsol were all revised down, with Eni alone being spared by the bank’s forecasters.
Those forecasters had a sound basis for their revisions: none of the factors that usually drive energy company stocks higher were present at the moment. Among these factors, as reported by the Financial Times, were expectations of higher inflation, higher interest rates, rising oil prices, and a subdued overall stock market.
“Going through the checklist, we find that none of these are in place at the moment. In fact, most of these factors are pointing in the opposite direction,” Morgan Stanley analysts wrote in a note predicting the immediate future of European supermajors.
Interestingly, Morgan Stanley lists higher interest rates as conducive to higher energy stock prices, when those are in opposition to another factor for higher stock prices, namely rising oil prices. When interest rates are high, oil prices tend to get pressured, and vice versa. But another factor that Morgan Stanley cited as a reason for pessimism about the energy sector was the discrepancy between oil demand and oil supply.
The bank said in an earlier report that the oil market would swing into oversupply in 2025 amid higher production from both OPEC+ and other producers, namely the United States and Brazil. Morgan Stanley, by the way, is not the only bank predicting a surplus. Goldman Sachs also recently forecasted a surplus situation, citing high global inventories, weak Chinese demand, and growing U.S. production.
If all these developments are indeed in progress, it’s bad news for the European supermajors. They just recently revised their strategies, reprioritizing their core business over experiments with so-called ESG investing over the past few years as they sought to get a piece of the transition action and suffered losses from it.
Yet here is the thing: the factors Morgan Stanley lists as precursors to a stock rout in oil and gas are not a fact. They are suggestions and possibilities. And they might never materialize.
Let’s take Morgan’s expectation for a surplus oil market in 2025. The specific numbers are demand growth of 1.2 million barrels daily and supply growth of 2.6 million barrels daily, both from OPEC and non-OPEC producers. Like others, Morgan Stanley assumes that U.S. output would keep growing at previous rates and that OPEC will begin rolling back its cuts at whatever price point Brent crude is trading. These are some substantial assumptions, especially in light of OPEC’s insistence it would only begin rolling back the cuts when market conditions are right. Brent below $80 does not seem to fit OPEC’s perception of the right market conditions.
Leaving the OPEC cuts aside, however, what about production? U.S. drillers have been serving surprise after surprise, reporting higher than expected output on drilling efficiencies, posting an unexpected output growth rate of about 1 million bpd for last year despite a lower rig count. Yet the assumption that this would continue regardless of where oil prices are going would be a bold one. Because in addition to drilling efficiencies, U.S. oil producers have been focusing on ensuring a certain level of shareholder returns at the expense of drilling just for the fun of it.
Then there is demand. All price forecasts, whether Brent crude or Shell’s stock, rely heavily on Chinese demand data and forecasts. The data suggests that the oil demand in the world’s largest importer of the commodity is losing steam after two decades of strong growth. This naturally weighs on prices—and on supply.
Reuters’ John Kemp reported last month that OECD oil inventories were 120 million barrels or 4% below the ten-year average at the end of June this year. This was up from a deficit of 74 million barrels at the end of March. In other words, the world, or at least the OECD part of it, was dipping into inventories to satisfy its oil demand. Those are very far from the surplus Morgan Stanley predicted for next year. Incidentally, OPEC+ is in no rush to roll back production cuts.
European supermajors have seen their stocks underperform their U.S. peers. However, the consensus on the reasons for that has had nothing to do with oil demand and supply. It has had to do with the much tighter regulation in Europe and the obligation to invest in non-core activities in the alternative energy segment of the industry. Those investments have not turned out well—despite upbeat analyst forecasts that this was the way forward and the supermajors were doing the right thing. Big Oil’s bets on its core business, on the other hand, have generally paid off, regardless of bank predictions.
By Irina Slav for Oilprice.com
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The predictions are based on flimsy assumptions such as high global inventories, weak Chinese demand and growing U.S. production. Yet global inventories are 120 million barrels (mb) or 4% below the ten-year average at the end of June this year. In other words, the world is dipping into inventories to satisfy its demand. Those are very far from the surplus Morgan Stanley predicted for next year. Incidentally, OPEC+ is in no rush to roll back production cuts.
Claims about weak Chinese demand are unsubstantiated particularly with the Chinese economy growing as projected at 5% and with China's imports hitting high level in August.
As for a growing US oil production, there is always an huge element of hype and inflation of production by 1-2 million barrels a day (mbd) being the difference between the EIA's weekly and monthly production estimates.
Moreover, there is no indication whatsoever that OPEC has any plans to raise its production other that what it announced earlier about phasing out its cuts by the end of September but this depends on oil prices. These plans could easily be put on the back burner if prices decline.
However, the litmus paper for global oil demand is the refilling of the US SPR. Out of 288 mb withdrawn by the Biden administration, only 27 mb have been replaced or 9.3% with US production hardly able to chip in.
That is why I find Morgan Stanley's predictions unsubstantiated. I even consider them a ploy to depress oil prices.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert