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Oil Makes a Comeback

Alfred Lee

Oil Makes a Comeback

  • Commodity prices have experienced notable gains in the last six months, driven by a number of tailwinds. These include optimism for an economic reopening, a weak U.S. dollar, inflation concerns and sizable supply and demand imbalances. The Commodity Research Bureau U.S. Spot All Commodities (CRB) Index, which tracks the spot prices of a broad basket of commodities, has returned 49.2% since the equity market bottomed in late March of 2020.
  • While we have seen a recent boom in commodity prices, one that has stood out in recent months is oil. Some of its gains can be attributed to price normalization, after the front month contract went to a negative value in April 2020, as COVID lockdowns intensified. However, its more recent gains have been driven by increasing demand as economies begin to reopen.
  • As COVID-19 cases have plummeted in areas with high vaccination rates, there are signs that we may have finally turned the corner on the pandemic. Moreover, as we head into the peak of summer, demand for oil will likely return much sooner than supply, as restrictions have started to loosen. Summer driving season typically places more demand on oil, as road trip vacations increase. With a number of companies also now calling employees back to the office, regular commuting will also bolster oil demand. Lastly, air travel has been on the rise, with passenger activity almost back to pre-COVID levels (Chart B).
  • On the other side, it is likely that demand will outstrip supply longer than the market anticipates. The Baker Hughes United States Crude Oil Rotary Rig Count tracks the number of permitted oil rigs in operation. While the number has steadily risen, it’s about 45% lower than pre-COVID levels. Although there has been some infighting among the Organization of Petroleum Exporting Countries (OPEC), which is expected to result in higher output, oil prices will likely remain elevated as an agreement is anticipated to be reached that will only gradually increase supply through the end of the year.
  • Higher oil prices will be beneficial for Canadian energy companies. Given that oil sands account for the majority of Canada’s oil production, which tend to be more cost intensive, elevated oil prices will be a positive for the Canadian energy sector’s forecasted earnings. The BMO Equal Weight Oil & Gas Index ETF (ZEO) currently provides exposure to an equally weighted portfolio of large cap Canadian energy companies. As North American economies continue to reopen, the demand for oil will likely increase and oil will need to be sourced from anywhere possible to meet demand.
  • In addition, with the global push towards clean energy, it is likely that capital expenditures for expanding infrastructure will be limited, which will also restrict how much supply can be increased over the long term. While renewable energy is the future, fossil fuels will remain a primary source until additional clean sources can come online. As a result, demand and supply imbalances within traditional energy sources such as oil could persist for a significant period, which would be a net positive for Canadian energy companies.


Chart A: Oil Starting to Outpace Commodities

Source: Bloomberg (WTI Oil to CRB Index Ratio), July 2, 2020 to July 2, 2021.


Chart B: U.S. Airline Passenger Activity Nearing Pre-COVID Levels

Source: Statistica (Measured as passengers screened at Transportation Security Administration (TSA) checkpoints), Jan-Dec, 2019-2021. As of June 6, 2021.


Chart C: Oil and Energy Companies Starting to Rally

Source: Bloomberg, December 31, 2020 to June 30, 2021


Alfred Lee

Oil Makes a Comeback

  • Commodity prices have experienced notable gains in the last six months, driven by a number of tailwinds. These include optimism for an economic reopening, a weak U.S. dollar, inflation concerns and sizable supply and demand imbalances. The Commodity Research Bureau U.S. Spot All Commodities (CRB) Index, which tracks the spot prices of a broad basket of commodities, has returned 49.2% since the equity market bottomed in late March of 2020.
  • While we have seen a recent boom in commodity prices, one that has stood out in recent months is oil. Some of its gains can be attributed to price normalization, after the front month contract went to a negative value in April 2020, as COVID lockdowns intensified. However, its more recent gains have been driven by increasing demand as economies begin to reopen.
  • As COVID-19 cases have plummeted in areas with high vaccination rates, there are signs that we may have finally turned the corner on the pandemic. Moreover, as we head into the peak of summer, demand for oil will likely return much sooner than supply, as restrictions have started to loosen. Summer driving season typically places more demand on oil, as road trip vacations increase. With a number of companies also now calling employees back to the office, regular commuting will also bolster oil demand. Lastly, air travel has been on the rise, with passenger activity almost back to pre-COVID levels (Chart B).
  • On the other side, it is likely that demand will outstrip supply longer than the market anticipates. The Baker Hughes United States Crude Oil Rotary Rig Count tracks the number of permitted oil rigs in operation. While the number has steadily risen, it’s about 45% lower than pre-COVID levels. Although there has been some infighting among the Organization of Petroleum Exporting Countries (OPEC), which is expected to result in higher output, oil prices will likely remain elevated as an agreement is anticipated to be reached that will only gradually increase supply through the end of the year.
  • Higher oil prices will be beneficial for Canadian energy companies. Given that oil sands account for the majority of Canada’s oil production, which tend to be more cost intensive, elevated oil prices will be a positive for the Canadian energy sector’s forecasted earnings. The BMO Equal Weight Oil & Gas Index ETF (ZEO) currently provides exposure to an equally weighted portfolio of large cap Canadian energy companies. As North American economies continue to reopen, the demand for oil will likely increase and oil will need to be sourced from anywhere possible to meet demand.
  • In addition, with the global push towards clean energy, it is likely that capital expenditures for expanding infrastructure will be limited, which will also restrict how much supply can be increased over the long term. While renewable energy is the future, fossil fuels will remain a primary source until additional clean sources can come online. As a result, demand and supply imbalances within traditional energy sources such as oil could persist for a significant period, which would be a net positive for Canadian energy companies.


Chart A: Oil Starting to Outpace Commodities

Source: Bloomberg (WTI Oil to CRB Index Ratio), July 2, 2020 to July 2, 2021.


Chart B: U.S. Airline Passenger Activity Nearing Pre-COVID Levels

Source: Statistica (Measured as passengers screened at Transportation Security Administration (TSA) checkpoints), Jan-Dec, 2019-2021. As of June 6, 2021.


Chart C: Oil and Energy Companies Starting to Rally

Source: Bloomberg, December 31, 2020 to June 30, 2021


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