Uncertainty Drives Investors to Oil Stocks

• Reuters: Oil stock buying has accelerated in recent weeks.
• Investors are seeking to insulate themselves against the worst by boosting their exposure to oil and gas.
• Kemp: portfolio investors had accumulated one of the largest bullish futures and options positions in gasoline since before the pandemic.

The energy industry has so far this year been the second-best performer on the U.S. stock market, right after communications. Oil and gas stocks are up by 17% since January—and investors are still buying.

It's business as usual for most, as oil prices climb higher amid Middle East tensions, OPEC cuts, and shrinking global inventories. But it's not only that, not this time. This time, investors are buying oil and gas stocks as a hedge against inflation. Perhaps there's more than one reason oil's called black gold.

Oil stock buying has accelerated in recent weeks, Reuters reported last week, noting rising oil prices and a stronger-than-expected U.S. economy. Yet despite the positive surprise from U.S. economic indicators, fear remains that there are turbulent days ahead, and investors are seeking to insulate themselves against the worst by boosting their exposure to oil and gas—the same sector that has beaten Big Tech this year.

 "If inflation is going to pop up again ... the hedge is to have some commodities exposure," one analyst told Reuters. Pop it may, too, after the March reading turned out to be higher than hoped for, quashing expectations of rate cuts. At 3.5%, the rise in consumer prices last month reawakened concern about the prospects of economic growth in the world's largest economy.

The situation is a little paradoxical. On the one hand, some economic indicators have surprised positively, fueling predictions of a "soft landing" or even "no landing at all," just growth as usual. On the other hand, inflation has just served up a nasty surprise to those expecting the Fed to start cutting rates before too long. The first development is bullish for oil. The second is not, at least not normally. And yet prices are higher. Stocks are higher, too.

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It appears investors have started paying attention to the fact that however a certain economy is doing, it uses oil. Even with inflation creeping higher, oil demand does not move much. And that is why the oil and gas industry has become such an attractive option for those looking for a hedge besides gold—which is running at record highs.

"Investors are looking at the world and they're seeing that the economy really isn't slowing down much ... at a time when there are various concerns over bottlenecks regarding supplies of commodities, especially oil," the president of financial planning firm Chase Investment Counsel told Reuters.

The situation in the Middle East is undoubtedly one reason for what investors are seeing. After Iran's retaliatory strike against Israel this weekend, there is a possibility that this situation will get even worse, adding to the war premium of oil prices due to the importance of the region—and Iran itself—as oil suppliers.

But more than geopolitics, arguably, it is supply and demand that is driving the strong performance of oil and gas companies and attracting buyers from the investment world.

"We are on track to have an extremely tight global oil market," Sebastian Barrack, head of commodities at hedge fund Citadel at the FT Commodities Global Summit earlier this month, as quoted by Bloomberg. "OPEC has definitely regained control."

Not only has OPEC regained control, but demand is proving more resilient than some expected, with Vitol expecting growth at 1.9 million bpd this year. The IEA, however, recently revised down its own demand projection, citing "exceptionally weak deliveries" in the OECD over the first quarter of the year.

This does not appear to have affected investor sentiment—quite the contrary, in fact. In a recent report, Reuters market analyst John Kemp said that portfolio investors had accumulated one of the largest bullish futures and options positions in gasoline since before the pandemic. That's despite long-term trends that have seen demand for the fuel decline thanks to efficiency gains, higher biofuel blending mandates, and EV sales.

The reason that investors have flocked to gasoline appears to be quite similar to the reason they are buying energy stocks: market imbalance with tightness in the supply department. Basically, investors are loving oil and fuels because they expect demand to exceed supply in the next few months, at least.

With first-quarter profit season kicking off soon, they might find more reasons to love oil and gas. Despite the IEA's grim conclusion that oil demand growth lost steam during the first quarter, it is quite likely that this did not hurt Big Oil's earnings in any palpable way, if at all.

Yet doubts remain about the future of this demand—for macro reasons. "The sobering reality is global activity is weak by historical standards and prospects for growth have been slowing since the global financial crisis," the IMF's Kristalina Georgieva said earlier this month. She added that "inflation is not fully defeated, fiscal buffers have been depleted and debt is up, posing a major challenge to public finances in many countries."

Bad as this may sound for bill-payers and their governments, it does not sound that bad for oil and gas demand—and the stocks of the companies providing the supply for that demand.

By Irina Slav for Oilprice.com

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