Daily Brief - Oil prices can sting. But not all stocks will hurt (Oct 12, 2021)

After an awful week, stocks fell again on Monday. The major equity benchmarks wavered between gains and losses throughout the day, as investors weighed the extent of the crude oil spike against the positive Covid news: Merck submitted its request to the Food and Drug Administration for emergency use authorization for a Covid-19 pill.

But there is plenty of good news in the commodity rally we are seeing. For some stocks, anyway.

For much of the past two years, investors and analysts have been focused on which oil companies can keep their costs down and return capital as dividends and share buybacks. That’s led to reduced drilling budgets, paid off debts and less ambitious plans for exploration of new oil deposits.

There is ample evidence that demand for oil and gas isn’t about to go to zero. In fact, the next few years could look much the same: characterized by high prices and underinvestment. For all the talk of diversification (and, in a nod to Tesla, solar energy!), Saudi Arabia is investing in expanding its production capacity to 13 million barrels a day from 12 million.

How do you invest for that kind of environment?

The latest Goldman Sachs report is worth a glance: their analysts are suggesting that investors consider companies with access to long-term sources of oil and gas. Among those are Hess (HES) with a stake in a major oil project off the coast of Guyana in partnership with ExxonMobil (XOM). Chinese company CNOOC (883 HK) is also expected to produce considerable amounts of oil for the next decade.

Pioneer Natural Resources (PXD) has one of the largest positions in the Permian Basin that Goldman expects to pay dividends for years — literally and figuratively. Small-cap Kosmos Energy (KOS) has promise because of an offshore natural gas project in West Africa that it’s constructing with BP (BP).

The road to a more sustainable energy situation will be long, and certainly won’t be smooth. With talk of the US government releasing strategic petroleum reserves and OPEC raising production, crude oil prices are bound to be volatile. However, it’s clear that months, even years of underinvestment in new oil production won’t be undone in a few weeks, or months.

It’s possible that only a turn in the business cycle can alleviate the energy shortage in the short term. The Fed, with an eye on rising oil prices percolating through to inflation metrics, will be a key actor in this drama.