OPEC Plus ESG Equals Higher Prices!

Oil markets were devastated by COVID in 2020, but it is really Environment Social Governance (ESG) investing trends that has had a bigger (longer-term) impact. Most understand that the future of energy creation will be in renewables. I am not sure transatlantic flights will every be on renewables, but one never knows what future technology will bring. The vast majority of using carbon-based energy will be phased out this half century. This means companies, on average, will invest less in new supply capacity. The question in basic price discovery is the intersection of supply and demand. Right now, demand is rising relative to supply that is being artificially contained by OPEC+. Today, there is plenty of excess capacity that could meet the demand, but OPEC+ and other major producers understand that by 2050, a world leading producer of energy will look very different. We believe OPEC will attempt to supply constrain prices higher for as long as possible.

For now, we need crude oil and supply constraints can push prices higher. We have seen $100-120 targets. Many suggest that emerging market demand plus depletion (due to lack of investment) can push prices significantly higher in the coming few years. But as you can see from this 10-year forward curve of (WTI) oil futures, the longer-term price is still in the $50 range. The price where marginal production is marginally profitable.

The current OPEC+ rift between Saudi Arabia and the UAE will likely be settled in the coming days, but perhaps it’s the highest level of OPEC uncertainty since Russia and the Saudis broke their agreement as COVID was devastating the world in March 2020.

Iran, Iraq, Libya and Nigeria always have extenuating circumstances due to geopolitical related uncertainties. Most recently, Iran and the broken nuclear agreement, has lost 2-3 million barrels of daily production. Venezuela with US sanctions also has lost more than one million daily barrels. The world has plenty of supply in the coming years, but we do see a strong trend where companies are not reinvesting in growing production. Depletion is an important factor in the coming years and may keep prices elevated for a few years.

We are no expert in the supply and demand dynamics of the energy markets, but those that are generally have this consensus view. It would seem that there is a trade here when the energy sector performs well in the coming few years. For us, it’s a trade, it’s not an investment. We do see a green future, but for now, the dynamics seem to support higher energy prices. The good news for the green future is that the higher carbon prices get, the faster the incentives move to a green low carbon future for energy production. For Canada, this is a big longer-term negative, but near-term positive given the global view of Canada as an energy producer and a petro currency.

Make sure you check out our weekly update in our PRO-EYES macro indicators each week to help figure out when it’s time to be cautious or when it’s time to be opportunistic. The recent readings suggest tactical risks in Q3 with extreme valuations, but central bank liquidity is still extremely supportive. We expect the FOMC could make a policy mistake if they are too aggressive in tapering.

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