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Should Investors Bet on Oil Hitting $100 a Barrel Soon?

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A year and half after the pandemic-driven epic oil price crash, optimism is back in the sector as prices have soared above $85-a-barrel, with talks of a potential spike of more than $100 from the top energy traders and forecasters like JP Morgan, Goldman Sachs (GS - Free Report) , OANDA, Rystad Energy. The bullish outlook is a far cry from the depths of minus $38 a barrel in April 2020.

According to Goldman Sachs, oil prices could reach the magic figure around the third quarter though the investment bank’s official target for 2022 is $96 a barrel. Jeff Currie — Goldman Sachs’ head of commodities research — believes that the oil market is “fundamentally tight” with a high probability of upside going into the first half of next year.    

While it’s typically a case of an ever-improving demand picture against constrained supply, let’s discuss the important dynamics driving the oil markets.

Could We See $100 Oil Again?

Following the historic plunge of 2020, the oil market has made a remarkable recovery, and a tight commodity market is clearly evident.

Apart from a favorable demand/supply dynamic, high vaccination rates in most parts of the developed world and the calibrated production cuts by the OPEC+ cartel, the commodity’s upward momentum is being supported by recent geopolitical headlines that could impact production. For example, the Russia-Ukraine tensions and the attack by Yemen's Houthi group on OPEC-member UAE gave a boost to oil by threatening supply disruptions.

Further, even though oil prices have rebounded strongly from the coronavirus-induced depths, most producers will likely continue with their disciplined approach to capital allocation in 2022. With not much chance of a significant upstream capex increase this year, investment in long-term projects appears to be dwindling.

For example, U.S. biggie Chevron (CVX - Free Report) has pegged its capital and exploratory budget for 2022 at $15 billion — at the low end of its previous estimation of $15-$17 billion. This year’s budget is also down around 29% from Zacks Rank #3 (Hold) CVX’s 2019 pre-pandemic expenditure of $21 billion.

You can see the complete list of today’s Zacks #1 Rank stocks here.

According to Chevron's Chairman and CEO Michael K. Wirth, the company is following a capital deployment strategy that is aligned with its plans to move ahead in tune with the global economic recovery. CVX’s policy of spending restraint and cost efficiency aligns with its goal to improve returns and lower carbon footprint.

This capital shortage, coupled with the slow pick-up in U.S. shale production, point to an impending supply shortfall against demand, especially with most individuals resuming activities post vaccination and pent-up consumption starting to take effect.

It also seems that fears of a slowdown in oil demand recovery from the Omicron variant are starting to subside, with the strain likely to be short-lived and less deadly than expected. At the same time, the available vaccines might be effective in neutralizing it, while the broad-based reluctance to reapply harsh lockdown measures averted a major hit to consumption.

Many oil traders believe it to be the perfect recipe to see a price spike north of $100 a barrel for the first time since 2014.

The Cost of Triple-Digit Crude

There is no doubt that the energy space has been tightening rapidly this year but revisiting triple-digit prices might not be the best news for the economy and the oil industry. As fuel rallies, there could be demand destruction, especially from the emerging economies that are not only sensitive to commodity prices and currency fluctuations but also are yet to fully recover from the COVID-19 pandemic. Also, $100 oil will not be sustainable for nations that depend heavily on imports as well as finished crude products. 

What Lies Ahead?

Though we do not see the price of a barrel of crude reaching $100 anytime soon, there is a strong argument building for a bull run in the coming months. Demand is set to surpass the pre-pandemic threshold of 100 million barrels per day once again this year, while supply from the OPEC+ coalition looks likely to remain restricted in the foreseeable future, considering the group’s lack of spare capacity. Moreover, 2020’s unprecedented price collapse has prompted operators to trim their exploration budgets by billions of dollars, translating into a relatively dry pipeline of new projects.

With all the tailwinds, the Zacks Oil/Energy sector has continued to move higher in 2022 after comfortably topping the S&P 500 leaderboard last year. While 2021 marked the best annual performance since 2009, with the space gaining 55%, crude has already risen more than 15% this year. Although still in its early days, the New Year has started on a highly bullish note for the commodity, which is trading at around seven-year highs.

Consequently, the top gainer of the S&P 500 this year is an energy-related name — Schlumberger (SLB - Free Report) . The oilfield services behemoth, which is scheduled to report fourth-quarter results today, is the best-performing stock with a year-to-date gain of 23.7%.

Should oil hit $100, the likes of SLB could be even bigger winners in the coming months. Elevated crude realization generally leads to wider margins for companies like Schlumberger that make it possible for upstream players to drill for oil.

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