- Top energy analyst Paul Sankey expects oil prices to fall further this year and in 2024.
- Rising supply and weakening demand have sent crude prices spiraling since late September.
- Here are four energy stocks that Sankey likes despite his cautious oil market outlook.
The oil industry pays attention when Paul Sankey speaks, and for good reason.
The widely followed energy analyst is frequently ahead of the curve, as evidenced by his warning in early 2020 that oil prices could fall below zero. After working at Mizuho, Wolfe Research, and Deutsche Bank, Sankey founded the aptly named Sankey Research a few months later. Earlier this year, Institutional Investor named him its top independent energy researcher.
Oil is now out of negative territory following a multi-year recovery, but despite a brief surge following the outbreak of violence between Israel and Hamas, the commodity has been crushed recently. WTI crude has fallen from $93 per barrel in late September to the low $80s, and Sankey believes oil will fall further.
The correction is being caused by an increase in supply. According to Platts data recently cited by JPMorgan, global oil inventory increased by 30 million barrels last month, which also noted that Russia’s reported resumption of diesel exports could flood the market.
Demand is also down due to high gas prices and the end of the busy summer travel season. In the event of a recession, less economic activity should result in even lower oil prices.
More supply combined with softer demand is a recipe for disaster for oil companies, and Sankey isn’t hiding his concerns. Instead, he believes that energy investors should brace themselves for more volatility.
“The first principle is always demand, and it’s just tough to really be bullish oil if you think the demand side’s going to get weak over the next year,” Sankey told Insider in a recent interview.
The ‘canary in the coal mine’ of the oil industry
Sankey predicts that oil prices will fall by up to 15% next year, to around $70 to $75 per barrel, where they were earlier this year before OPEC announced price-boosting production cuts.
According to Sankey, oil producers are in a bind. They will have fewer exports but higher profit margins if they limit production. Higher oil prices, on the other hand, would put additional pressure on consumer and business demand, potentially causing – or worsening – a recession.
“They don’t want oil too high because it becomes — especially in this economic environment — it becomes self-defeating for them,” Sankey said of the oil industry. “And obviously, if they’re at a relatively low capacity utilization, they have to think about the extent to which they really want to squeeze the market here.”
“It’s worked very well for them to push the oil price up, but if you look at the impact on global demand — especially with a strong dollar — it could ultimately cause greater economic weakness, greater demand weakness,” Sankey added later. Their main concern is high demand. As the lowest-cost producer, they perform best when demand is high.”
The alternative is also unappealing, as an increase in output would cause crude prices to plummet. Oil producers in the United States should be concerned that Saudi Arabia may reverse its supply cuts and flood the market, bolstering its competitive position while driving prices even lower.
“There is a scenario — which is the downside scenario we’re talking about — that Saudi loses patience, which it’s done twice in the past decade, and actually opens the taps in order to maintain market share and revenues,” Sankey said in a statement. “And by doing so, we obviously crush the oil price back down probably to where we were when they started the cut.”
Instead of focusing solely on oil prices, Sankey believes that energy investors should pay close attention to what he considers the best indicator of the oil market’s health: refining margins.
The profitability metric has dropped significantly since its summer high, and Sankey expects the trend to continue as Saudi Arabia’s cuts keep prices artificially high and weaken demand.
“Refining margins are still good-ish — they’re certainly better than we’ve seen many times in the past,” Sankey said in a statement. “However, the dynamic is overwhelmingly negative.” That is to say, they are falling.”
Later, Sankey stated, “The primary concern for oil is refining margins.” There is no more important canary in the coal mine.”
Although refining margins are declining, Sankey believes a long oil market drawdown is not a foregone conclusion.
Geopolitical tensions are becoming a more serious threat, and as the conflict in Israel and the Gaza Strip has demonstrated, an unexpected outbreak of violence can cause oil prices to skyrocket. Sankey cited a number of developments that could disrupt supply, including the possibility that Russia halts the flow of Kazakhstan oil or limits its own production further voluntarily or involuntarily.
“Crazy things happen in oil,” said Sankey. “It’s the unknown unknowns that can affect supply.”
4 top energy stocks to keep an eye on
While US oil producers face numerous risks, including the possibility of a recession caused by the Federal Reserve, Sankey remains optimistic about the domestic economy.
“If you look at the structural problems in China, if you look at the bureaucratic challenges in India, if you look at the political capital in Africa and Latin America, and you look at all of the above in Europe, you end up concluding that the US is going to be by far the strongest economy in the world,” he said.
Unfortunately, renewed recession fears have recently crippled stocks. This includes energy stocks, which, according to Sankey, are “brutal to own in a recession.”
However, oil giants such as Exxon (XOM) and Chevron (CVX) will fare well if markets collapse because they are cash-generating machines with strong balance sheets, according to Sankey.
“If you’re in an extreme negative viewpoint, these guys will continue paying dividends, buying back stock, et cetera, because their balance sheets are really powerful,” he said.
Sankey went on to say, “On a long-term, structural basis, the oils are undervalued relative to the profits that they’re going to generate.”
Patients who can afford to hold a stock for five to ten years should consider Valero (VLO), a San Antonio-based petroleum refiner, and Plains All American Pipeline (PAA), a midstream energy company. However, Sankey cautioned against expecting quick and easy returns from either.
“We really don’t want to be pushing people into these things at what is seasonally a weak time for oil, which is after Labor Day,” Sankey said in a statement. “We would tend to be looking towards January, February next year before we were saying, ‘OK, these things could be oversold by now.'”