Since its peak in June the price of oil has fallen by around $30 a barrel. Crude is facing potential issues with both supply and demand. Greg Bonnell speaks with Andriy Yastreb, Energy Analyst at TD Asset Management, about the outlook for oil and why he remains bullish.
- Well, the price of oil continues to feel the weight of a looming global slowdown. Crude down about $30 from its peak back in June just as the Fed and other central banks started aggressively hiking interest rates. Now, despite the growth concerns out there, my next guest says the outlook for oil long-term still remains bullish.
Andriy Yastreb, energy analyst at TD Asset Management, joins me now. Andriy, always great to have you on the program. These are very interesting times, indeed, for all asset classes, including energy. What are you seeing out there?
ANDRIY YASTREB: So thank you for having me, first of all, Greg. And I think when I think about oil in this environment and for next six to 12 months, I like to think about three key drivers here. One of them would be Russia; another one, OPEC; and another one is potential recession. And I call them ROR to memorize.
I think one thing that I would like to start our conversation with is OPEC, and I have a chart here to show how it influenced performance of energy in the past. So if you look at this chart, it shows basically performance of the energy sector relative to the S&P 500 since 2000. And when I looked at the data, I realized that there is basically two different regimes that happened over the past 22 years. In one regime, I call it OPEC is your friend as an investor. And the other regime is OPEC is your foe.
So when OPEC's a friend, what I mean by that is that OPEC has control over energy market. It can influence the supply demand balance and influence price. And that's basically what happened early on from 2000 to about 2013. And during that time, energy did really well. It outperformed the broader market by 7% on average per year and outperformed in most of those years. So it was consistent, quite significant outperformance.
Then, in 2014, OPEC started fighting for market share with the US shale. And the picture completely changed. Since 2014 through 2021, energy actually underperformed by about 14% per year and underperformed in most of those years.
The good news here is that I think, now, OPEC is again in the driving seat. I think OPEC doesn't have that much spare capacity left. And last two meetings, they first increased production by 100,000 barrels. Then they now decrease production by 100,000 barrels, which tells you that, A, they don't have that much spare capacity left. And, B, they want oil prices to be higher.
- All right, so we hit the middle part of your ROR-- little systems you have going there, OPEC and its half. What about Russia? I mean, this seems like such a wild card in terms of this invasion that really turned everything on its head earlier this year.
- Yes, and it's-- we almost got used to it that it's going on, and there is all these sanctions on Russia. But we need to keep in mind that the actual sanctions on Russian oil haven't started yet. They start in December. And we don't really know how it will play out because if you look at the other sanctions that we had in the past-- for example, sanctions on Iran-- despite the sanctions, Iran is still selling oil on the global market. Maybe not as much as they used to, but there's still-- the oil is still flowing.
We will see how this impacts the market overall because, A, Russia is much bigger a supplier of oil than Iran. It supplies over 5 million barrels of crude oil and also over a million to million and a 1/2 of product. And, B, these sanctions are not only designed to limit sales of Russian oil to Western world. It also limits Russian ability to ensure their cargos and tankers. And that one is-- might be really tricky for Russia to circumvent. So we don't know exactly how much Russian barrels may be taken off the market. And that's big unknown for the next three, six months.
On top of that, there is another risk. And what we've seen in Europe is that Russia already cut gas exports to Europe to pretty much zero. And from that perspective, Putin was obviously interested in using energy as a weapon. He used already all his leverage in terms of natural gas to Europe.
If things don't go well for him in Ukraine, maybe he turns to oil and starts reducing oil exports as well. So I think Russia is one critical factor to watch. And it's possible, most likely in the near term, next three to six months, it could be a positive catalyst for oil prices.
- Yeah, so we have that there. Let's get to the last R, of course-- fears of recession, a global economic slowdown, what it means for supply and what it means for demand, really, ultimately, if the economy turns southward on a global scale. I think you have a chart there as well in terms of what we're seeing in that dynamic supply and demand.
ANDRIY YASTREB: Yeah, so this chart, it shows the crude inventories in the United States. And one interesting point is we were talking about supply and OPEC inventory being tight or OPEC's per capacity rather being tight.
What's interesting that-- usually if it's that tight, if OPEC doesn't have any more barrels to put in the market, you'd say, well, oil needs to be $100-plus. But we're not seeing that right now. It's in the low '80s. And I think this chart explains to a big extent why.
And If you look at that green line, that's all crude inventory in the United States, including the SPR, the special strategic petroleum reserve. And that strategic petroleum reserve has been drawn down quite significantly here in the past 10 to 11 months. And what's interesting about that is that release of SPR barrels is expected to end in October. So as I was talking about Russian sanctions kicking in December, in October, we also--
- And the Americans have no more oil to throw on the market either--
- --to the SPR.
- Exactly. And the cynic in me says that, why are we having such a big SPR release? Historically, we've only had the strategic reserve for real emergencies when there is a war somewhere, there's a natural disaster that limits actual production and access to oil globally.
Well, this time, it didn't really have a emergency anywhere on that magnitude. But we are releasing a million barrels a day in the United States. And, conveniently, that stops right before the elections in US.
So we'll see what happens going forward. But from that SPR release, that might be another potential positive driver because that's 1 million barrels a day. That's a large amount of oil that has been released.
GREG: So we got a lot to watch there. We got Russia. We got OPEC. We've got fears of recession. At $85 right now on my screen for American benchmark crude, 85.18, what does this mean for energy companies?
- Well, two months ago when I was here for an interview with you and we were talking about energy, we touched on recession and potential demand destruction due to high oil prices and what happens in a recession. And usually if you have a recession-- obviously oil is very cyclical. It does go down. And if you have a bad recession, your demand goes down significantly. And you have a lot of volatility. And, obviously, COVID was the worst case of that.
I think that, looking at what OPEC has done, surprising by announcing 100,000 barrels cut, that was very notable because, A, it was a surprise. Nobody expected that. And, B, I think that that's a signal that OPEC is ready to step in and support the markets even if the overall economy deteriorates and oil prices start going down.
So just going back to the first chart that I showed, on relative performance, one interesting part on that chart, those vertical black bars, they were showing years when S&P returns were negative. And in five out of those six years, energy actually outperformed versus the index. Still, it's relative performance. So if your index is down 30% and you're only down 25%, it looks like 5%. But you're still down.
- Just don't do as bad as the next guy, right?
- Exactly, but it is interesting from the standpoint that we usually think about energy is a very high-volatility, high-cyclical industry. And the data shows that, well, not exactly. Like, when OPEC actually has control of the market, when OPEC is there managing supply and demand and trying to balance it, energy performs pretty well.
GREG: So longer term, then, how should we-- I mean, everything's been so volatile from day to day. And it can turn your head around as an investor. But if we sum all that up and when you take a look at the crude space six months, a year, two years, what's your feel for the market?
ANDRIY YASTREB: Well, I think, fundamentally, market is tight because for the last five, seven years, oil prices were low. And that was driven by that OPEC fight with shale. And a lot of companies underinvested. And we are seeing the tightness in the market today and that drove oil prices over $100 earlier this year.
My thinking on that is if we go into recession next year, probably, we see more volatility. We'll see oil prices lower at some point. Maybe that triggers OPEC to step in and cut and balance prices. But if you do have a recession, I think what it means on the high level is that oil companies and oil executives look at that, and they decide to invest less.
So for the next year or two, we might still see more underinvestment. So on the way out of the recession, you'll still have the same supply issues.