Under the Radar Report has focussed a great deal on the advantages of investing in renewable energy and batteries, but the flip side is making money from fossil fuels despite declining usage. We look at why the oil price is heading higher and the outlook for producers.

Read more about Investing in Small Caps. Why we picked these ASX Small Cap gems and their outstanding performance.

Still positive on oil stocks

The oil price is heading higher and we believe there is still value in many oil stocks. Why? Oil will remain an essential commodity until new technologies take over. The number of project approvals will continue to fall, and the projects that are approved will be smaller, with shorter mine life. On top of this exploration will fall. Bank finance is already harder to get for fossil fuel projects. Why would you spend time looking for something that won’t be in high demand in 20 years’ time? This is exerting pressure on supply as oil reserves are depleted. The impact is higher prices.

During the depths of the pandemic, the West Texas Intermediate crude oil price collapsed to below zero in April 2020 as the world locked down. Today, its price is almost US$70 a barrel and although there are some countries that are still badly affected, the world is recovering from Covid following the rollout of vaccines. Mobility is being slowly restored and the oil price is recovering, despite increasing action on emissions targets and increasing use of solar and wind power on top of the transition towards electric vehicles.

Oil is at its highest since 2020. If the current price is exceeded, an earlier price resistance area from July 2018 points to a possible medium-term target of US$75/barrel. Oil could ultimately go much higher than this.

Why it is still worth investing in oil stocks

The main uses of oil are in transport and for chemical products. Yes, it has been shown that power generation can be rapidly switched, at least in part, to renewable sources. But it will take much longer for alternative sources to make a dent in substituting for oil in motor vehicles, trains, ships, and aircraft and for chemical feedstocks.

After demand fell from close to 100m barrels per day in 2019 to 91m in 2020, the International Energy Institute projects demand to recover to 96.5m in 2021 and then grow to just over 103m by 2025.

Peak oil demand

However, peak oil demand should occur much more quickly than might have been envisaged a few years ago. In the medium term, oil demand will remain firm until the new technologies to replace oil are fully developed and commercialised. It will take time for the massive existing stock of cars, trucks, buses, ships, and aircraft to be replaced.

Forecasts for new electric cars as a percentage of all new cars are 20-25% by 2025 and 40-50% by 2030. This means internal combustion engine cars will still be in production for many years on top of the consumption of oil by older cars.

Oil supply side considerations such as ESG

Oil companies are now subject to renewed scrutiny from institutional investors, finance providers, the media, green movements, and governments. The recent election in the US of a Democrat to the Presidency has accelerated these trends. The contractor we cover in Blue Chips Worley (WOR) recently noted that an increasing number of major oil and gas companies are now setting net zero targets and beginning to modify their strategies. Some are looking to join the ranks of renewable energy providers.

Supply dynamics are changing. Environmentally challenged oil projects are now less likely to get off the ground. Oil companies, fearing low oil prices in the long term, are less likely to commit significant capital to new long-life projects that no longer stack up from a valuation perspective. Financing organisations such as banks, under pressure from their own shareholders, are now less willing or unable to finance oil projects. Further, potentially weaker future oil cash flows risk debt repayments and provide a further reason for financiers to walk away from oil projects or offer terms that are less attractive.

The key takeout for ASX investors

The combination of increasing short-term demand and the reduction in new oil projects and likely oil exploration will tighten the supply-demand balance, likely leading to higher oil prices. This is why it is definitely worth investing selectively in oil stocks that have existing producing and high-probability growth assets.

5 highest performing Oil Stocks on the ASX

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