A closer look at gasoline and oil prices

Gasoline prices remain in the headlines, and leave an impression every time a driver fills their tank as prices hit new highs.  

Oil prices are a global issue, with OPEC and the US being the biggest producing regions. Producers face mixed incentives about increasing production longer-term, including messages from the futures markets.

Gasoline and diesel refiners face reduced capacity, leaving them struggling to meet even historically normal levels of demand despite high potential profit margins.

Commodity prices post record surge, near-term inflation to follow

Commodity markets have become the center of global economic and financial market attention recently, showing unprecedented volatility. Russia’s invasion of Ukraine, coming on top of the volatility caused by COVID and the subsequent policy responses, has highlighted the supply constraints now facing a wide variety of commodities.

The S&P GSCI commodity price index is a widely-watched benchmark for global commodity prices, with history back to 1970. As shown in the chart below, the rolling 3-month percent change in the GSCI index has just hit its highest reading in its 52-year history. This exceeds the moves following the OPEC oil embargo of 1973-74, the 1979 oil shock, the invasion of Kuwait in 1990, the rebound in prices in 2009 after the 2008 collapse, and the rebound in 2020 from the initial COVID-driven collapse.

Market impacts of Russia’s invasion of Ukraine

While we hesitate to comment too much on the situation in Russia/Ukraine given how fast conditions are changing, many investors are naturally interested in the market impacts of the recent invasion and the resulting sanctions.

The first order impact is clearly volatility, in many different markets. Stocks, bonds, currencies, and commodities are all seeing increased volatility recently amid extreme uncertainty surrounding the unprecedented global response to Russia’s invasion of Ukraine. And of course, Russian assets of all kinds have seen their prices plunge, if they are still being traded at all — the Russian stock market has remained closed since February 25th.

Energy sector supported by recovering output and elevated prices

We remain overweight the Energy sector, as analysts continue to raise earnings estimates and the sector is very favorably valued, though the picture has become somewhat more mixed as crude oil prices have been volatile recently. News of the new Omicron variant of COVID-19 and corresponding constraints on international travel have renewed concerns about fuel demand, while OPEC’s decision to go ahead with output increases has reduced the earlier concerns about insufficient supply.

Big moves in energy markets

Volatility in the crude oil and natural gas markets has been a big topic among investors and policy makers recently. Limited supplies and higher demand are pushing prices higher, and stock prices in the Energy sector are responding.

The chart below helps put recent movements in perspective, seen in the context of the last five years. Crude oil prices (second section, in red) have just recently topped their 2018 peak, completing a full recovery from the COVID-related drop and weakness that preceded COVID. But the five-year average for crude oil has been about $55/bbl, with a low of $25 (on this measure, which uses an average of the next 12 months of crude oil futures contracts to avoid near-contract distortions) and a current high of $76. So crude is elevated but not at an extraordinary level given it was at about the same price in October 2018. And it reached much higher levels above $100/bbl. back in 2008, 2011, and 2012.

Energy sector has rallied, but optimism is already high on crude oil

The recent returns of the Energy sector have been dramatic: in just two weeks from its latest trough on November 6th (just before the Pfizer vaccine news hit), the S&P 500 Energy sector rose 37%, the biggest return of any of the major sectors by a wide margin. The overall S&P 500 index, meanwhile, returned only 3.6% in that period. Most recently, the gains in Energy have cooled somewhat, but the sector (as of Dec. 2nd) is still up 30% from its November 6th level, well ahead of all other S&P 500 sector returns over the period.

Big divergences in commodity space still favor Materials over Energy

One of the themes in our sector research for clients recently has been to focus on relative preferences within broader style or macro categories, rather than making big macro bets on Growth versus Value or Cyclical versus Defensive areas. We find that in a more range-bound market with conflicting macro trends, a more granular view is often more effective.

One stance we have held for some time has been within the Value-oriented commodity space. While in many cases historically the Energy and Materials sectors have moved together, this year has seen a dramatic divergence between the two commodity-related sectors. We have favored Materials over Energy this year, and still do, and below are some of the drivers of that view.