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Get Think Tanked Distilled with Fernando Valle

Posted by Michael Venuto on Jul 19, 2022 10:30:00 AM
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Energy stocks have soared over the past two years thanks to a post-COVID recovery, Russian oil shock, and a lack of supply. In recent weeks, they have gone bust again as the demand forecast continues to deteriorate. What’s ahead for this sector and when will its current challenges get worked out? Fernando Valle, the senior oil & gas analyst at Bloomberg Intelligence, joins to ETF Think Tank to give us his thoughts.

The Fed is in the process of raising interest rates to cool demand, but what effect will rate hikes really have on the oil market? Valle says that tighter Fed policy won’t be able to fix the current supply issues, but it will have a lagged effect on demand. Inventories are already low, so it will be difficult to get a rebuild in supplies right away, so this imbalance could continue for some time. A lot of energy is used for transportation and agriculture and the demand for that won’t necessarily decline significantly. There are some things, such as less home construction, that could assist in lowering demand.

Valle does see one major impact to the sector from the Fed’s actions. If the Fed raises interest rates by 100 basis points, we will see lower investments made by the major players, lower demand, and higher unemployment. All of these corresponding factors will ultimately decrease demand. The supply side likely won’t be fixed for possibly several years. We won’t end up seeing the results of current investments made until at least 2025.

We are, however, seeing an uptick in investment. ExxonMobil, for example, has raised its capex by more than $10 billion. ConocoPhillips has gotten larger primarily through acquisitions, including more acreage and new developments. Some of the things preventing companies from moving faster are the same things affecting the rest of the economy, namely the inability to hire enough workers and that’s created some bottlenecks. Production has been growing, but it will likely take a while for it to reach the previous peak again.

Valle sees the current shakeout in energy stocks being a function of two factors. First, the markets do not think that current price levels are sustainable. Second, there is a perception that the transition to clean energy will decimate these stocks. The Russia/Ukraine war has highlighted how energy demand won’t just fall off a cliff. Even as the transition continues, it will take years before electric puts a big dent in traditional oil demand.

Other key takeaways:

  • What about the gas stimulus checks that some states are talking about? Valle says they are not a good idea because they do not address the core supply destruction problem. Emerging markets already do a lot of subsidizing, but that just puts additional pressure on the state and does not foster the investments that could help the supply issue.
  • Valle says the biggest roadblock to getting gas prices down is generating enough oil production, which will take time. There is a bureaucracy side that also impacts imports/exports and that tends to drive some costs higher. The biggest thing is making new investments, but that will take time to ramp up.
  • Valle says that Russia actually isn’t the biggest risk to the energy sector outlook. It’s the Fed. He notes that financial derivatives are currently being sold at the highest pace since April 2020. The upside case for oil prices would be an escalation in Ukraine. The winter is when the upside risks could play out. Will Russia cut off Europe? Europe will need some sort of insurance policy. They could work to reactivate shuttered capacity, but it is probably too late.

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