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Explainer: Why are oil prices rising again?

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Two months after Joe Biden announced an effort among major oil consuming economies to work together to bring down rising fuel prices, prices are again approaching multi-year highs. And Biden has few options to stop the rally.

Global benchmark Brent crude passed $84 a barrel on Wednesday and leading analysts are forecasting that oil could pass $100 a barrel in the first quarter. [O/R]

Biden helped foster a coordinated release of oil from strategic reserves with Japan, India, South Korea, Britain and China in November that helped quell prices – even though, in the end, China did not take part.

Brent briefly dropped below $70 a barrel, but the effects were short-lived.

Rising oil prices present a political headache for Biden and any U.S. president, because the United States is the biggest consumer of gasoline globally, burning roughly 9 million barrels per day (bpd) of the motor fuel. Crude prices make up about two thirds of the price of gasoline, making the commodity’s price an important part of consumers’ budgets.

Republicans are pointing fingers at climate-focused policies supported by Biden, a Democrat, for rising prices.

Investors have been buying oil on expectations that the Omicron coronavirus variant will have a limited effect on global economic activity. Currently U.S. pump prices are about 80 cents a gallon below their all-time record hit in 2008, but they are expected to rise.

WHY ARE OIL PRICES RISING AGAIN?

Worldwide oil demand recovered to pre-pandemic levels at roughly 99 million bpd, but supply is at least a million bpd short of that, according to the International Energy Association.

Economists say the combination of strong demand, weak investment and a lack of spare capacity has caused prices to rise. The Organization of the Petroleum Exporting Countries and its allies, including Russia, a group known as OPEC+, have been routinely falling short of targeted supply increases.

“OPEC+ remain steadfast in adding 400,000 bpd back to the market each month, but our data suggests that monthly additions tally closer to 250,000 bpd,” Mike Tran, commodity strategist at RBC Capital Markets, said in a note to clients.

U.S. production averaged roughly 11.3 million bpd in the second half of 2021, compared with a peak of about 13 million bpd at the end of 2019.

CAN’T BIDEN PRESSURE OPEC AGAIN?

Biden last year joined his predecessors who at one time or another pressed OPEC to raise output, with variable success.

The president announced several steps to try to bring fuel prices down in November. The White House, in conjunction with Japan, South Korea and India, announced a release of barrels from its strategic reserves.

Biden had also said China would be involved, but the country, the world’s largest crude importer, said it would sell from its reserves on its own schedule.

The group cut supply by a record 9.7 million bpd in early 2020 as the pandemic broke out. It has been slowly restoring output, but currently OPEC+ is still withholding more than 3 million bpd in supply.

WHAT ARE BIDEN’S OTHER OPTIONS?

Biden could increase sales from the U.S. Strategic Petroleum Reserve (SPR). However, that supply is limited, and pales in comparison to the size of the global market.

SPR crude inventories have fallen to 593 million barrels, their lowest since November 2002.

Biden’s announcement in November was for a release of 50 million barrels in sales and loans – roughly half of one day’s global consumption.

The president could also consider a federal gas tax holiday; the federal excise on gasoline is 18.4 cents a gallon.

In 2008, lawmakers floated this idea in response to a surge in prices that brought gasoline costs to more than $4 a gallon – but because refiners cannot quickly produce more gasoline, such a move would likely only boost demand, which would ultimately send prices higher, economists have argued.

ENERGY SHARES ARE ON FIRE, STOKED BY INFLATION

Shares of U.S. energy companies are soaring in the early days of 2022, driven by a shift to so-called value stocks and assets that stand to benefit from the steepest inflation in nearly four decades.

The energy sector is up over 14% this year, against a 0.8% drop for the overall S&P 500. Energy also posted the biggest gains of any S&P 500 sector last year, rising nearly 48%.

Several factors are behind the sector’s performance. Brent crude has surged about 23% since early December and is near its highest level since late 2018.

Rising energy prices have been a key factor over the past year in pushing up overall inflation. Consumer prices last month had their largest annual gain since June 1982.

“If oil is on the rise and natgas is on the rise, it is going to mean an increase in earnings for those companies that are involved in the energy sector,” said Robert Pavlik, senior portfolio manager at Dakota Wealth Management. Pavlik is overweight the energy sector in his portfolios, owning shares of Chevron and Pioneer Natural Resources.

S&P 500 energy companies overall are expected to increase revenue by 72.7% for the fourth quarter from the year-earlier period, according to Refinitiv IBES. Oilfield firms Baker Hughes and Schlumberger report next week.

Energy’s 12.2% spread over the median sector performance in the first week of 2022 ranked as the second-biggest weekly outperformance of any sector over the past decade, according to Willie Delwiche, an investment strategist with market research firm All Star Charts.

“The group has a pretty good record of outperforming the market in inflationary periods and we are in an inflationary period,” said Peter Tuz, president of Chase Investment Counsel Corp. The wealth management firm’s energy stock holdings include Chevron, Baker Hughes and Halliburton.

The sector’s outperformance also reflects a broader shift from tech and high-growth stocks that jumped last year to companies that stand to benefit from higher Treasury yields, as surging inflation increases expectations the Federal Reserve will be more aggressive in normalizing monetary policy.

The S&P 500 growth index is down nearly 3% so far this year, while the S&P 500 value index, which is more heavily weighted in shares of energy firms, banks and other economically sensitive and comparatively cheap companies, has risen 1.5%.

The relatively small size of the 21-company energy sector, which has a 3% weight in the S&P 500 compared to a nearly 7% weight for Apple alone, means that even small shifts in investors’ portfolios could buoy energy stocks.

“When you see all the selling that is going on in the megacap tech stocks, if even a fraction of that money finds its way into the energy sector, the stocks ought to do well,” Tuz said.

The energy sector’s robust gains follow years of underperformance amid volatile commodity prices, company struggles with capital discipline and investor wariness of fossil fuel investments. The sector remains down about 7% since the end of 2011 against a 620% gain for the technology sector over that time.

Signs the Fed may not be as aggressive as expected in raising rates could raise the allure of tech companies, which tend to be particularly sensitive to higher yields, and sap some demand for energy stocks. Concerns over slowing global growth also could weigh on crude prices.

For now, however, analysts appear confident oil prices will remain strong.

Energy stocks are “well placed” for 2022, analysts at UBS Global Wealth Management wrote on Wednesday, pointing to their expectations of Brent remaining between $80 to $90 a barrel this year and the sector’s above-market dividend yields.

(Reporting by Jessica Resnick-Ault; Editing by Heather Timmons, David Gaffen and Marguerita Choy)

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SourceReuters

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