Making the case for upstream investment in 2022
Published 14th January 2021
by David Stent, Content Manager, Energy Council
The pandemic years of 2020 and 2021 inflicted troubles onto the market that were difficult, if not impossible, to forecast. The initial period of uncertainty led to a record number of contracts entering a state of force majeure, industrial and manufacturing demand bottomed out and the lack of information about how society will adapt all led to a widespread cessation of investments into oil and gas exploration and production. One result of these inhibitors is inevitably lower production schedules and a raft of delayed projects that naturally take time to gain momentum once more. The consequence herein is that production volumes are dominated by national actors who seek to reverse their losses over the initial demand slump by maintaining high-price levels as demand returns to a normalcy.
Many doubts arise when considering investment into Upstream in 2022; will there be expanded restrictions on funds and financiers, or will there be a repeat of the demand slump in early 2021, or will OPEC+ utilize their reserves to shift the price point to one that suits their objectives best. Such uncertainties will often worry the generalist investor but for the energy specialist with experience of the oil and gas cycles, the near future looks far more enticing.
State of the markets
Demand for oil and gas shows little sign of ceasing over the medium-term as economies seek to balance their climate commitments with consistency of supply. The prevailing expectation is that the energy transition will not be the end of the oil and gas sector, instead global demand will continue to drive strong returns as we have seen over the past year.
Initial concerns that the high transmissibility of the Covid Omicron-variant would trigger a similar demand collapse as early 2020 has largely failed to materialize while unexpected supply constraints have helped to maintain oil above $80/barrel – a price point that should bolster investor confidence looking ahead to the new year.
Of course, climate ambitions have introduced uncertainty toward how regulatory changes may inhibit oil and gas investment and finance, yet the belief among most states and regional blocs is that O&G resources will remain crucial to economic activity. Moreover, following the economic damage of Covid lockdowns, travel restrictions and supply chain hiccups – most governments are reluctant to place any extra burdens on their short-term economic recoveries.
Absolute investments on the up
As projects regain their momentum, there will be a steady increase in upstream investment compared to the previous two years with Rystad’s research pointing to $456 billion in capital committed to upstream investment across upstream oil and gas markets this year. The figure represents a 9% increase on the $418 billion, most of which came from the $307 billion to upstream oil projects with the remaining $149 billion in upstream gas investments.
Much of these investments have been committed over the course of the previous two years and will be reflected in the development of a range of Greenfield projects – this commitment to developing new assets reflects the growing belief among upstream players that price levels will remain at elevated price points.
Upstream natural gas and LNG developments reflect the largest growth in investments, up 14 % from 2021, as demand for the fuel accelerates as a more carbon-friendly alternative to oil and coal. This has been reflected in the success of the natural gas funds that saw a year-end period of historical high prices. The focus on gas is further with the 18% increase in global upstream shale investments.
While 2020 left a bitter feeling as stocks plummeted, the converse was largely true for 2021 in which investors saw many energy funds grow with exceptional value. Naturally, the riskier (and more costly) complex funds benefited from the higher year-end surge with up to 165% returns, while the more prominent index funds ended up ‘only’ 56% higher, according to the Wall Street Journal's top energy funds for 2021.
One of the more popular energy index funds, State Street Advisor’s Energy Select Sector SPDR ETF (XLE) grew steadily to end the year up 53% with a low expense ratio of just 0.19%. However, the standout ETF over the past year went to First Trust Natural Gas’ ETF (FCG) – up 89% by year-end buoyed by record natural gas prices toward the end of 2021 as it tracked the ISE-Revere Natural Gas Index.
Vanguard’s ETF (VDE) is a sound bet for those with a lower risk appetite spread across a diverse set of oil and gas companies (as well as other select commodities) and finished the year 56.2% up. Invesco’s Dynamic Energy Exploration & Production ETF (PXE) was another success story with their focus on upstream oil and gas benefiting from year-end highs and finishing 2021 up 103%.
The Complex Funds of Direxion’s Daily S&P Oil & Gas Exploration & Production Bull 2X Shares (GUSH) came in 130% at year-end and of MicroSectors’ U.S. Big Oil Index 3X Leveraged ETN (NRGU) finishing up 165%.
Of the individual stocks to choose from, the supermajors and large independents have shown their resilience with strong gains on the previous years’ subdued performances. Stand out performances from ConocoPhillips (NYSE:COP) saw 52-Week Returns up 80.4%; ExxonMobil (NYSE:XOM) enjoyed a strong year up 53.2%; while BP (NYSE:BP) gained 26% – despite each remaining below pre-pandemic levels, their capacity to weather price shocks has allowed for robust rebounds.
The large independent gas producers, Cenovus and Cheniere, excelled after a suppressed start to 2021. As gas prices rose so too did their stock, Cenovus witnessed a superb 104% increase in their share price from January 1st 2021 to 2022 and Cheniere enjoyed a 60.4% stock price jump over the same period.
Forbes notes that “the average upstream company gained 127.4% in 2021”, and that 26 of the 55 companies analysed as upstream operators enjoyed returns greater than 100% for the year. The winner, in terms of overall gains, was Baytex Energy who saw a phenomenal year with a return of 476.5%.
Final considerations for 2022
Looking forward to the new year the markets have remained bullish in the face of fresh Omicron fears that may lead to supply disruptions. Two years into the pandemic the risk appetite is returning and the specialist energy investors are making hay while the sun still shines on oil and gas.
Consumer demand is expected to grow once more in light of more established Covid protocols, higher vaccine uptake and an acceptance of the endemic nature of the virus. The inability of COP26 to establish new frameworks to cut emissions further strengthen the position of oil and gas producers who were wary of new barriers to production. That being said, ESG measures are expanding and those who are proactively engaging with the transition may stand out as preferable stock picks.
While some quarters are wary of a demand decline that collapses oil prices, the prevailing thought is that both will maintain their position above $70/barrel for Brent Crude. JP Morgan holds the boldest view, that oil will surpass $125/barrel in 2022 and $150/barrel in 2023. Few share this stance, Rystad are closest to forecast an outlook of $100/barrel, dependent on OPEC’s actions. Two more conservative outlooks come from Goldman Sachs forecasting $73/barrel and Standard Chartered with a $75/barrel outlook for 2022 – a position that holds against a Reuters poll of 35 economists that averaged $73.57/barrel. The EIA is even more conservative with a $62/barrel price point for the WTI by year-end 2022.
Natural gas prices are expected to fall from their record year-end highs, stabilized by a milder winter, increased production volumes and the restoration of storage capacity. While it will still be some time before oil and gas prices are consumer friendly, the elevated position remains positive for investors.