ASX energy shares have bounced and may have more room to climb as the market is underestimating the strength of oil’s recovery.
This analysis by Citigroup that was reported by Bloomberg would come as a relief to investors fretting that this is as good as it gets for the oil price.
The price of crude is trading just under US$60 a barrel after it staged a spectacular turnaround from the COVID-19 mayhem.
As good as it gets for ASX energy shares recovery?
The WTI benchmark even crashed into negative territory for the first time in history last April, while Brent bottomed around US$20 a barrel.
Oil-exposed ASX shares have also seen a dramatic turnaround in their fortunes. The Woodside Petroleum Limited (ASX: WPL) rallied by two-thirds since the S&P/ASX 200 Index (Index:^AXJO) bottomed in March 2020.
Huge surplus of oil dampens outlook
It’s been nothing short of an extraordinary year for ASX energy shares. The virtual grounding of international travel and a shock global economic recession brought oil demand to its knees.
Bloomberg reports there are still more than a billion barrels of surplus oil slushing around the world despite the economic recovery.
The amount of excess oil is concerning to some. It comes even in the face of the rebound in Chinese economic activity, OPEC supply discipline and increasing transportation demand.
Why oil could surprise on the upside
This might be why some investors are reluctant to buy ASX energy shares out of fear they have already missed the boat.
But this sentiment could be furthest from the truth.
“The recovery is proceeding at a faster rate than people perceived,” Ed Morse, head of commodities research at Citigroup Inc. told Bloomberg.
“The demand recovery is going to look stellar. The inventory draw is significantly greater than what many people thought.”
Backwardation fuels the bulls
Morse is backing up his bullish claim by pointing to an uncommon pricing event in commodity markets. The oil market is in backwardation.
This is when the near-term futures price for oil is higher than the longer-term price. The difference in contracts for oil to be delivered in December 2021 has surged to a two-year high of US$2.84 compared to contracts to be settled a year after.
During normal times, markets are in contango. This means the price of a commodity is lower for nearer-term delivery than it is for longer-term deliver.
A key reason for this is to reflect storage costs plus a premium for future uncertainty.
But when markets are in backwardation, it reflects usually high near-term demand for the commodity.
The effect of oil being in backwardation is that producers have a financial incentive to deplete inventories as quickly as they can.
That massive surplus of oil may not last as long as some might believe.