December 11th, 2021

The Oil Rollercoaster

investment-in-oil

Dear Retail Investor,

Few investments present the kind of narrative you get with oil.  

It’s one of the most highly traded commodities in the world, with a global market worth over $5 trillion and counting.

It has been referred to as “black gold” and the “lifeblood of the modern economy.” 

Because it is . . . at least for now. 

Oil is used in many ways: as a key component for energy generation, transportation fuels and petrochemical products such as plastics, solvents and adhesives. 

This means it’s highly lucrative. And because it’s unevenly distributed, it’s also highly political.

The result is that oil is very volatile and greatly influenced by politics, weather, sentiment and even unprecedented events like a global pandemic, for example. 

Speaking of which . . . 

Oil went negative during the COVID crash

It makes no sense at first, but yes—on April 20, 2020, one of the world’s main oil prices (the West Texas Intermediate, or WTI) ended the day worth less than nothing

This was due to a range of factors including, of course, the onset of a once-in-a-century pandemic that messed up supply chains and dramatically sliced the almost 100-million barrel a day oil market.

There was suddenly nowhere to put it, which was evident in the the critical storage hub at Cushing Oklahoma, where oil that trades on the US futures market is delivered. 

The market basically broke. 

You may recall the story of the poor daytrader who bought hundreds of oil futures contracts during the plunge at $.01, only to be told he owed $9 million after a tech issue prevented his trading platform from displaying negative oil prices.  

Nobody wanted oil—and nobody wanted oil stocks, which proceeded to bottom out over the following months along with collapsing global demand. 

Fast-forward to the present

And we’re now in the commodity rollercoaster. 

The price of oil enjoyed a nice rally after its 2020 lows, with WTI going up over 300%, from
-$37.63 to $84.65.

Oil stocks also enjoyed a healthy rebound, rewarding diamond-handed investors who bought and held during the rough months. 

But then Omicron and ongoing economic uncertainty took its toll. 

Black Friday took Brent and WTI oil prices down by more than 10%, in the largest one-day drop since that fateful day in April 2020. 

November saw a 20% price drop, the worst since March 2020. The plunge was attributed to fears over Omicron, growing anticipation that the US Federal Reserve will start hiking rates in the near future, and expectations that coming emergency reserve releases will juice growing supply. 

In other words, oil brings hefty volatility. 

And now, oil is set for a comeback

This is oil, after all, and a couple days can mean everything.

After the latest dip, bulls have come roaring back, pointing to the Dec 2 Organization of the Petroleum Exporting Countries (OPEC) meeting, where it was decided to somewhat maintain the current pace of oil output increases, but to leave the meeting open.

Meaning, they are prepared to put a floor under prices by cutting output.  

Various pundits point out that this likely signals a floor. There are a fair number of conservative oil price predictions now floating around, ranging from Barclay’s tidy forecast of $80 per barrel in 2022 to the JPMorgan estimate that boldly proclaims we could soon see oil prices rise to $150 by 2023, due to limited supply from OPEC and the inevitable (if slightly delayed) economic recovery. 

These lofty oil price forecasts we heard back in the fall are re-emerging. And who is to say that it will not overshoot to the upside, especially if we steer out of the COVID doldrums once and for all. 

Either way this shakes out, the fundamentals remain in place, with oil demand set to continue in the decades ahead. Estimates of when peak oil demand will hit range from 2025 to many decades beyond that

Renewable energy is surely coming in a big way, but the transition will require oil and it will not happen overnight.  

So where does this put investors who are looking for ideas in 2022?

Look for Value

It’s never easy to buy anything after a significant run. 

Nor should it be. 

But while oil has enjoyed a strong surge from the COVID lows, so has much of the market. The recent turmoil is not unique to oil, but is rather broad in scope.

And it has presented an attractive window.  

While the prospect of a worldwide weaning off of oil and gas in the coming years is ever-present, the demand says otherwise. 

One only has to look at the natural gas price crisis in Europe to see that renewables still have a way to go. 

There is also the economic strength emerging from the COVID pandemic. Omicron may prove to be more mild than scaremongering headlines lead us to believe. And if it’s more transmissible than Delta, then we could actually be looking at the beginning of the end of the pandemic. 

The popular oil benchmark, the Energy Select SPRD ETF (XLE), is marching towards its pre-pandemic levels, as is the Canadian equivalent Horizons S&P/TSX Capped Energy ETF (HXE). 

Meanwhile, some of the more well-known oil stocks are showing signs of consolidation and strength. 

For those looking for a “safer” large cap play, Suncore (TSX: SU) offers a unique advantage as Canada’s largest oil sands producer, having recently doubled its dividend with more good news on the horizon as it spends its cash hoarde from strong oil prices over the last year. 

While not an oil producer, oil pipeline operator Enbridge (TSX: ENB) offers an arguably more stable pick, with a heafty dividend and some potential upside. 

For those wary of dividends in the oil industry (fair enough), some added risk could prove very rewarding over the next couple years. 

Tamarack Valley Energy (TSX: TVE) is an aggressive mid-cap focused in the Western Canadian sedimentary basin. Their year to date revenue at Q3 came in at a strong 100%+ growth over last year and Q4 is expected to follow this trend. With increased production coming online next year, as well as expected share buybacks and exploration in the exciting Clearwater area in Alberta, 2022 could be a good one. 

A smaller player, Cardinal Energy (TSX: CJ) focuses on four core areas in Western Canada. They barely survived the COVID oil downturn, but are now rapidly turning around. The company  is quickly decreasing its net debt and fixing its financials, with a dividend reinstatement plan on the horizon for 2022. The company has provided guidance for $120 million in free cash flow in 2022 (using at WTI price of US$70). So if oil overshoots that target, well—that’s great. 

There are many more great oil companies to choose from, many of which have used the recent price run-up to deleverage and prepare for the year ahead. 

For oil investors, 2022 could prove to be pivotal, as the long-awaited end to the pandemic looms and with it, a resurgence of demand as the global economy fully recovers. 

And when this happens, you can bet oil will be powering it. 

Dear Retail Investors Editorial Team

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