Will oil prices stay high to propel energy stocks?

Favorable supply and demand dynamics may bode well for oil and gas producers.

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Key takeaways

  • Energy stocks have been volatile in recent years.
  • Restrained oil and gas supply growth and rapid inventory depletion could support higher oil and gas prices.
  • Higher prices could boost exploration and production stocks.

Energy stocks had quite a year in 2021: It was the best-performing sector by a wide margin. Could 2022 be another positive year for this sector, or might energy revert to being one of the worst-performing sectors, as it has been in prior years?

The answer will likely be dictated by oil prices. If global economic growth and mobility (air travel, trucking, and other forms of transportation) continue to improve, while global crude oil supplies remain constrained, high oil prices may be here to stay in 2022. For energy stock investors, higher crude oil prices likely mean increased profits—and potentially higher stock prices—for energy exploration and production (E&P) companies in particular.

Are higher oil prices here to stay?

Global crude oil prices, as measured by North Sea Brent Crude (a specific type of oil that's used as a price benchmark in the global oil market), hit a multiyear high in December 2021—more than 4 times the recent low of $20 in the spring of 2020.

Demand for crude oil has recovered faster than expected as economies, and in particular auto and trucking industries, have rebounded from the COVID-driven slowdown. Robust economic growth and continued recovery in air transportation in 2022 could drive global oil demand above even pre-pandemic levels.

Oil supply, meanwhile, has been slow to rebound due to a number of factors. Oil companies have been placing greater focus, with their spending, on developing cleaner fuel sources. Some oil projects have been delayed due to COVID-related logistical challenges. And some oil companies have simply been spending less in general, due to high debt levels incurred earlier in the pandemic and increased focus from investors on corporate capital discipline. As a result, supplies from non-OPEC nations have been slow to respond to the rise in oil prices.

Natural gas prices hitting record highs

Natural gas markets have experienced a similar but even more extreme price recovery. Natural gas prices in Europe and Asia traded at record highs in the range of $25 to $30 per million British thermal units (or mmbtu, a measure of energy value), which is approximately 3 to 5 times normal levels.

Natural gas is facing similar supply issues, with low spending on projects in the early stages of development. In addition, several unexpected weather trends, including cold winters in Europe and Asia, low wind speeds in Europe (reducing windfarm output), and a severe drought in South America (reducing hydro output) have boosted demand for natural gas and have depleted inventories to low levels. Natural gas prices are so high that power plants and other industrial users are switching to more highly polluting coal and oil to get through this difficult period.

E&P companies may be worth considering

In terms of who might benefit from sustained high prices, investors may want to look toward E&Ps. In particular, some Canadian oil and gas producers have strong upside exposure to high oil prices and long-duration oil and gas reserve bases, and also trade at discounted valuations to many large US competitors. Some US-based E&Ps may also be able to return large amounts of capital to investors via dividends and/or share buybacks.

Though weather will continue to play a factor in the oil and gas markets, underlying demand for oil and gas should continue to grow as economic growth continues, while supplies are likely to remain relatively restrained. As a result, oil and gas producers may continue to enjoy strong profitability and stock performance in 2022.

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