Vaccine rollout drives energy's rise
But the sector's current tailwinds are likely unsustainable, so investors should prioritise high-quality businesses with stable balance sheets, says Morningstar's Dave Meats.
Dave Meats: For the second quarter in a row, the Morningstar US Energy Index eclipsed the overall market, beating the aggregate index by over 28 per cent in the first quarter. The ongoing rollout of COVID vaccinations is the primary driver, since the reopening of the global economy should eliminate the need for the stay-at-home orders and travel restrictions that have been suppressing crude demand in the last 12 months.
We still think global consumption will be back at 2019 levels within two years. Nonetheless, their offer has challenges. European countries are on the brink of extending lockdowns into April, given rising infections and the safety and effectiveness of the AstraZeneca vaccine, in particular, has been called into question in some parts of the world.
However, this does not derail our thesis that developed countries can achieve herd immunity during 2021. Prospects for the full global herd immunity have receded given the spread of vaccine resistant strains, especially in emerging economies where vaccination rates are lagging. But vaccines still lower the risk of serious disease, even if they don't prevent infection as effectively.
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So, life can still mostly return to normal around the world, and that should support a recovery in crude demand. But producers remain cautious. Despite the recent oil rally, OPEC remains skeptical on the pace of the recovery and has extended cuts into April.
Likewise, US shale firms are reluctant to increase activity, and volumes could contract slightly in 2021 year on year. As a result, the market looks very tight in 2021, which is why WTI crude prices have climbed past our $55 a barrel midcycle forecast. Unless we see a meaningful setback in COVID vaccinations or an abrupt change in strategy from OPEC, or the US shale industry, then this frothiness could persist for much of 2021.
But long-term investors should be mindful that these price levels are higher than the marginal cost of supply and are unsustainable. So, while energy stocks still look cheap, we no longer expect a commodity tailwind, which means investors should be picky and prioritise high-quality businesses with stable balance sheets. Our top picks include Exxon, Schlumberger, and EOG Resources.
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