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An oil pumping jack in Kansas.
Angus Mordant/Bloomberg
Oil prices and stocks enter 2022 in strong shape, having outperformed the market handily in 2021 after a decade of lagging behind.
Energy stocks in the S&P Composite1500 rose 49%, large diversified oil companies rose 45% and oil producers rose 86% in 2021. Oil prices rose 50%, persevering through several Covid-19 variants, and other economic challenges like supply chain bottlenecks. Brent oil, the international benchmark, was recently trading at $78 a barrel.
But 2022 presents new challenges, not the least of which is that oil is starting the year at a much higher level than one year ago—leaving less room for upside.
Analysts are generally optimistic about the industry for 2022. Many companies have fixed their balance sheets, and announced new dividend and buyback programs that should reward shareholders.
“We believe that energy is poised for another year of outperformance relative to the broader market led by explorers and producers,” Mizuho Securities analysts wrote on Monday, recommending that investors buy
EOG Resources
(ticker: EOG) and
Chevron
(CVX) to profit off the next move.
But there are big questions ahead—some of which could sharply change the industry’s trajectory. The three biggest unknowns to the start the year are OPEC’s plans for balancing prices and market share; Russia’s intentions in Ukraine; and production levels by U.S. producers. If the first two factors defy expectations, prices could spike; if the third surprises, they could drop.
OPEC members will give investors a sense of where they are headed on Tuesday at the group’s next meeting. OPEC and its allies (known as OPEC+) are scheduled to add 400,000 barrels of oil production starting in February, but will have to take into account the surge of Covid-19 in some countries and whether it will depress demand and prices.
OPEC is also facing political risks. Late in 2021, oil-consuming countries including the U.S., Japan, and China announced plans to release reserves from government-controlled storage tanks in an attempt to depress prices. That coordinated action was unprecedented and marked a new era for oil prices—if OPEC does too much to raise prices, oil consumers may attempt to depress prices on their own.
“OPEC members will have to balance their desire to build back their foreign exchange reserves and sovereign-wealth fund war chests against the desire to keep the powerful consuming countries content,” wrote RBC Capital Markets analyst Helima Croft. “We think the group will be closely watching for additional mobility restrictions as governments contend with the fast spreading Omicron variant and OPEC+ could still hit the pause button on production increases if Brent appears set to have an extended stay below $70.”
There’s a good chance that OPEC balks at raising production, argues Nareeka Ahir, a political risk analyst at S&P Global Platts. Ahir assumes “a freeze of February quotas at January levels, although U.S. pressure could trigger another increase.” Holding production flat would likely cause oil prices to rise. Croft, on the other hand, expects that OPEC will move ahead with a 400,000 barrel-per-day increase.
One member of the OPEC+ alliance could cause a much bigger shock. If Russia invades Ukraine, it would likely spark sanctions from the U.S. and others that could cause energy prices to rise. “We think the market impact of such a military confrontation could be very consequential, especially given Europe’s already precarious energy supply situation,” Croft wrote.
While moves by OPEC and Russia may exert upward pressure on prices, a third factor could cause prices to slump. U.S. producers have pledged to bring back production slowly, so that they can focus instead on spending money on shareholder returns. If they stick to their guns, it would keep prices high.
But there are signs that some producers are getting antsy to cash in on high oil prices, and may want to pump more. Historically, overproduction often leads to oil busts. The U.S. Energy Information Administration has projected a relatively gradual rise in U.S. production, to an average of 11.8 million barrels per day in 2022 up from 11.7 million in November 2021.
A recent survey, however, indicates that some companies are particularly interested in ramping up output. The Federal Reserve Bank of Dallas’s latest energy survey of companies in Texas, Louisiana, and New Mexico found that 49% of them consider growing production to be their top goal for 2022. And one other data point may be even more telling—the companies are making plans based on average oil prices of $64 a barrel, well above their planning assumptions for prior years. In 2019 and 2020, they used $54 as the benchmark.
If companies start expecting oil prices to stay high for a long period, they may begin exploring more—possibly leading to the next price drop. That could quickly curb the industry’s momentum.
Write to Avi Salzman at [email protected]
