It might not be good news for motorists that the oil price rallied quite strongly during the past week, but oil producers and companies that benefit from higher oil prices are smiling. A few investors are smiling too.
The benchmark Brent crude price surged from $76 a barrel a week ago to above $82, the highest level since its last peak of $86 in October 2018. In fact, except for this quick run in 2018, oil prices are at their highest since 2014, when they came crashing down from above $100 per barrel.
In SA, Sasol shareholders benefitted nicely.
The share price increased more than 30% since September 20, from around R220 to R294.
Ironically, it is the relentless lobbying by environmentalists that is pushing the oil price higher, causing the rush into oil shares, and making investors rich.
Vaughan Henkel, head of equity research at PSG Wealth, calls this “an unintended consequence”. He also mentions that chemical and energy companies are still largely reliant on oil producers, despite accepting environmental concerns and starting to move to more sustainable energy sources.
“However, this will take at least 10 years and probably much longer,” says Henkel.
The push against fossil fuels and environmentalists’ strategy of targeting investors in and funders of oil and coal projects has resulted in a shortage of capital, leading to the cancellation of projects to develop new oil reserves and increase production.
In turn, this created fears of a shortage of energy following the recovery in demand after the [worst of the] Covid-19 crisis.
Lagging green goals
While the energy world is moving away from fossil fuels to greener alternatives – with Sasol itself recently announcing that it aims to ‘green’ its operations by 2050 in accordance with climate change agreements and goals – the world will still be dependent on oil and coal for at least the next decade.
“Crude [oil] is still expected to remain in high demand over the next decade to make transportation fuels and petrochemicals used for plastics and other household products. US consumption has surged lately following the worst of the coronavirus pandemic and output cuts by the Organisation of the Petroleum Exporting Countries (Opec) have given prices a further boost,” according to an analysis by Bloomberg.
“If consumption continues climbing beyond 2022 as many expect, the world would then need more oil from the same companies currently being told by investors to limit spending, resulting in a supply shortfall,” explains a report by the influential Financial Times.
Opec goes so far as to say that progress in the implementation of a number of sustainable development goals has either stalled or reversed, as the Covid-19 pandemic undermined years of efforts on this front.
“The year 2020 saw little progress in United Nations (UN) climate negotiations owing to Covid-19. Climate diplomacy moved to (only) informal discussions held in virtual mode,” according to Opec’s latest monthly review of the oil market.
“A number of parties announced their new targets and measures, yet the estimated emission reductions resulting from their implementation fall far short of what is required to achieve targets.
“The fulfilment of developed countries’ commitments on critical issues such as climate finance would be required for all countries to be able to enhance their mitigation action and reduce vulnerability to the harmful effects of climate change,” says Opec, implying that poorer countries cannot afford the new, but more expensive, green energy.
“The world is still short of achieving universal energy access. Eradication of energy poverty should, therefore, remain an overarching goal for resilient and sustainable development. International cooperation and solidarity are more important than ever,” according to Opec.
“The central principle to leave no one behind must be kept at the heart of efforts toward achieving all sustainable development goals.”
The Opec report says demand for oil has proved to be resilient and is increasing as economies around the globe are recovering, but that supply from non-Opec countries has been declining. As a consequence, prices have been rising.
The Opec reference basket price averaged $70.33 per barrel in August, increasing more than 60% since the beginning of the year.
Many got it wrong, some got it right
It seems a lot of experts got it wrong.
Opec mentions in its report that hedge funds and other money managers continued to reduce their net long positions to oil during August, to the lowest levels since November 2020.
Others got it right. Goehring & Rozencwajg (G&R), an investment company specialising in natural resources, explains its decision for betting on oil: “Over the past 18 months, oil markets experienced their largest dislocation in history. Because of Covid-19 restrictions, demand collapsed and inventories swelled.
“Prices fell to a previously unthinkable -$37 per barrel in April 2020 as traders were forced to pay to have crude taken off their hands,” say the fund managers at G&R.
“At the same time, producers rushed to shut-in production and curtail drilling activity. While investors panicked, we turned to our models and concluded the market would tighten much faster than anyone thought possible.
“We doubled our oil and gas exposure and have enjoyed the rebound ever since.
“Despite the price action in both oil and oil-related equities, investors remain bearish. Investors today are fixated on two things: Opec spare capacity and competition from electric vehicles.
“While these factors need to be monitored, investors are ignoring how tight oil markets have become and how much tighter they will get as we progress through the rest of 2021 and 2022.
“Over the longer term, ESG-led activist investors have all but ensured non-Opec production will fall dramatically, leaving Opec with increased market share and pricing power.”
Needless to say, Opec is not advocating for lower oil prices or green energy.
Meanwhile in SA, Sasol shareholders are benefiting from the increase in oil prices (and the weakening of the rand), as the recent surge in the share price shows.
The view from PSG Wealth is that there is more to come. Henkel reiterates that Sasol provides exposure to rising oil prices and a weakening rand.
“Sasol provides a true direct investment in oil and acts as a rand hedge,” says Henkel.
“The recent strengthening of crude oil, and the expectations of continued strength as economic activity continues to increase post Covid-19 restrictions globally, are good for the energy sector.
“Sasol stands out. The share offers value at the current price, trading at a price-to-earnings [PE] ratio of around 7.5 times, even after the recent run.”
Henkel says Sasol could advance to R400 (slightly above the current intrinsic value of R348), which will represent a PE of 10 times the earnings of around R40 per share (recently announced for the year to June 2021).
“This is a reasonable rating and indicative of the relationship between the Sasol share price and earnings over the past 15 years – i.e. the share price is typically 10 times the earnings over that period,” he says.
On a forward enterprise value/Ebitda (earnings before interest, tax, depreciation and amortisation) multiple of 3.8 times, Sasol is also trading at a discount to its fair value, says Henkel.
“It represent a 30% discount to its five-year average of 5.6 times and, coincidently, a 30% discount to that of its peers.”
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