FANG - Oil Can Still Hit $100 Per Barrel And XLE Investors Can Benefit

2023-06-26 13:02:14 ET

Summary

• Oil prices could reach $100 a barrel if central banks ease monetary policies in response to deteriorating macroeconomic indicators.
• The U.S. Strategic Petroleum Reserve's inventories are near record lows, and geopolitical tensions or unexpected events could push oil prices higher.
• Risks to this outlook include a prolonged global recession and a continued sufficient supply of oil from OPEC+ members and US production facilities.

Energy Select Sector SPDR® Fund ETF ( XLE ) investors have not been making too many gains in the past several months. The oil prices seem to be stuck between the Fed and the Chinese economic slowdown. Even though Saudi Arabia's oil production cut held the commodity's price up for a few days, many traders are worried. I am also not particularly optimistic when it comes to the condition the global economy is in. And I believe a further economic downturn will have a bad effect on oil prices. But I still remain cautiously bullish. I will explain the scenarios under which the oil prices may well touch the $100 per barrel mark.

The Chinese economy's downturn

A lot has been written here about the Chinese economy, its downturn, and the falling oil demand in this country. My fellow Seeking Alpha contributor Logan Kane described the situation as quite complicated . However, paradoxically, there is also a piece of good news for Chinese investors and the future health of the economy. That is because the Chinese government has already started taking fiscal and monetary measures to improve the key indicators. We all know that recessions come and go. When the economy is overheated, most governments and central banks start tightening the conditions to slow down the inflation readings. But when the outlook looks grim, then they start intervening to save the economy.

In my view, if this has already started happening to China, the chances are this would happen to the US soon enough. I have personally been a doomsayer for a while. After all, many indicators are already quite poor, the inflation rate has decreased, whilst the Fed is not getting particularly dovish. At the same time, "this too shall pass". By this, I mean that eventually, the Federal Reserve would have to stop hiking the interest rates in order to avoid the next Great Depression. The current lower energy prices are also good for the inflation readings. CPI, PPI, and core inflation are all indicators Powell pays close attention to. If they go down, the Fed will be free to ease the monetary policies. The point I am making is that lower energy prices lead to higher energy prices in the future. But the bullish factors are not over yet.

Saudi Arabia's oil production cut

Saudi Arabia needs the oil prices to be $80 per barrel for its state budget to avoid going into deficit. Right now, the commodity is somewhat cheaper. So, being part of OPEC+ they have reached a deal to cut the oil output. At the beginning of June , Saudi Arabia's energy ministry said the country's output would total 9 million barrels per day in July, a decrease from around 10 million barrels in May. This makes a record large reduction in the last several years. Despite this, the oil prices are not reacting much. I think the market is ignoring this, which is not very rational.

XLE ETF consists of sound companies

As I have mentioned in my previous article on Energy Select Sector SPDR® Fund ETF, it consists of large companies with sound credit ratings. Their stocks have depreciated much less than the Brent and crude oil prices due to their solid balance sheets and profitability.

As I have mentioned in my previous article on XLE ETF, most companies of this oil ETF have an investment-grade credit rating.

XLE components

Source: Author

The point I am making is that the ETF encompasses large companies and is diversified. Obviously, this means that XLE is not so volatile.

This can be well seen from the diagram above. Even though the oil prices (Brent oil on the graph) fell significantly, the XLE remained almost unchanged. Most companies can make a profit at the current oil prices. But XLE will obviously do much better if the commodity prices move higher. I will explain how the oil price surge might be possible.

How can oil reach $100 per barrel?

As has been mentioned by many analysts but largely ignored by traders and investors, the oil levels in the SPR (the US strategic petroleum reserve) are at their multi-decade lows.

This can mean two things. First, the White House administration might have to refill the reserve in the near future. Otherwise, if the reserve is not refilled on time, the US can face big challenges if there is an unexpected oil supply deficit.

As you can see from the diagram above, the oil stocks are near 40-year lows. In fact, such an inventory level was only seen at the beginning of the 1980s when the Strategic Petroleum Reserve was founded to help the US avoid the situations it faced in the 1970s when there was a full-scale energy crisis.

Let us not forget that the driving season has just started thanks to the people's vacations in the summertime. Moreover, many countries in the Northern Hemisphere are suffering from an unprecedented heat wave. All this raises the demand for fossil fuels.

Then, Europe can face serious issues with its supplies. It might seem as if the energy crisis in Europe has come to an end. However, this is not entirely so. The main reason why many European countries' economies did not suffer from energy shortages last winter was because of the very mild weather conditions. But the oil and gas deficits may likely persist this autumn and winter if the weather gets cold.

Some geopolitical tensions may escalate, like more sanctions imposed against Russia, which may substantially lift the energy prices. This is not my base-case scenario but this is well possible. Moreover, there has always been uncertainty in the Middle East region. For example, the conflict between Saudi Arabia and Yemen may start again, even though there was a peace agreement in April this year . The situation in Iran may get more complicated as well. By this, I mean tougher sanctions and other problems . The point I am making is that political tensions are hard to predict. But they may fuel plenty of enthusiasm about oil on Wall Street, pushing the prices of oil stocks and XLE ETF upwards. In fact, we may reach $100 per barrel or above, if you just look at 2022.

Risks

The key risk to my thesis is a deeper recession than expected. If the macroeconomic indicators decline further and many central banks, including the ECB and the Fed, fail to react, the global economy may enter a very prolonged recession. This situation would likely take years to solve. So, the oil prices will stay under great pressure for a while. This is the biggest risk I see.

Right now, there is also a sufficient supply of oil due to the OPEC+ members and the US production facilities. At the same time, this too may pass. A geopolitical conflict or weather conditions may change the whole story.

Conclusion

Although the oil prices are low right now, it does not mean the situation won't change. The deteriorating macroeconomic indicators around the world may push central banks to ease monetary policies. The SPR's inventories are near record low levels, whilst it was a wonder that Europe avoided the tough energy crisis last winter. Any geopolitical tensions and any unexpected events might indeed make the oil prices even reach the $100 mark.

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