There are many areas in financial markets that are higher than before the onset of Covid-19. Despite a significant hit to demand, oil is now above the levels of February 2020.

Oil is one of the best indicators of global economic demand, so we watch it closely. Global stockpiles grew rapidly during the start of the pandemic as the world stopped using around one quarter of its daily needs. Whilst we have not got back to the daily volumes of 2019, demand is now recovering. The oil price was initially supported by supply adjusting as the price collapsed. This was mostly done by OPEC+ (the name for the OPEC oil cartel plus Russia). As the world started its recovery, OPEC+ commenced the addition of 400 thousand barrels a day each month. Recent negotiations will see these monthly additions accelerate in April 2022. This will continue until their spare capacity runs out sometime in the second half of 2022 when demand should be much closer to “normal”.

The chart below courtesy of Goldman Sachs, shows the movement of global oil stocks in millions of barrels. As you can see, they are reducing quickly confirming the need for OPEC+ to increase production.

Source: IEA, EIA, Kplr, JODI, PAJ, PJK ARA, IE Singapore, Oilchem, Reuters, Goldman Sachs Global Investment Research

If demand remains supportive, we can see the oil price continue to move higher despite the increasing OPEC+ barrels. This is largely because the rest of the world is not investing in new oil fields as much as they have in the past. The world is decarbonising with an acceleration in the roll out of electric vehicles and greater investment in renewables. Knowing this, financial markets are making it more difficult for companies to access capital to invest in new oil fields.

This is a major reason why we are seeing the share prices of most ASX listed energy companies no longer reflecting the rising oil price. There are some stock specific reasons, but many investors think the disruptions of electric vehicles and renewables are too great. Others feel the oil price will fall back so are not prepared to factor in the current oil price into their valuations.

One consequence of this is a growing likelihood of mergers and asset sales. Very recently, Santos made a bid for Oil Search as both companies share ownership in some assets. The argument put by Santos was that it will be in a better position to fund and develop Oil Search’s growth pipeline which is not progressing like Oil Search had hoped.

For many decades, BHP has held a petroleum business alongside its mining operations which has made it unique. Today, it is facing growing ESG concerns from its investors across the globe to decarbonise. It is almost out of thermal coal now and there have been recent media reports that it is looking to exit out of oil and gas too. It now has a smaller pool of potentials buyers for these assets, but Woodside Petroleum is rumoured to be involved.

Since most oil companies are finding it more difficult to grow production, this could see oil move to US$80 a barrel and possibly beyond in the next two years. Whilst the profits of such companies would benefit in the interim, it could accelerate the move away from oil as electric vehicles and renewables become more attractive economically. The irony is that higher oil prices can actually bring forward the roll out of electric vehicles.