First, oil prices peaked, and now gas prices are touching record highs, especially at a time when most Americans embark on their road trips during the summer season.
According to the Wall Street Journal, U.S. oil prices peaked at around $120 a barrel in March when the Russia-Ukraine conflict shook the world. Currently, crude is trading at around $115 a barrel.
It is interesting to note that as oil prices have recently dropped from their peaks, gasoline prices have crossed $4 per gallon across all U.S. states.
According to the data shown below from the AAA Gas Prices website, regular gas prices now average around $4.619 a gallon and have surged a whopping 51.7% compared to the year-ago period.
So What’s Driving the Price Levels?
As the COVID-19 pandemic hit the world, oil consumption and prices dropped due to reduced economic activity and movements as a result of global lockdowns. According to the U.S. Energy Information Administration (EIA), during the pandemic, gasoline demand in the U.S. dropped to 8 million barrels a day before peaking at 9.33 million barrels a day in 2018.
Post-pandemic, however, as economies opened and restrictions eased, global demand for oil and gas sharply recovered from pre-pandemic levels. More specifically, the U.S. economy has recovered from its shutdowns at a higher-than-expected pace, leading to a strong demand-supply gap for fuel.
Taking a sharp upturn, higher oil and gas prices have returned with a vengeance, and there is no stopping the escalation.
Notably, the demand-supply gap is not the only reason behind the price rise. Let’s take a look at all the other underlying reasons acting as the tailwind.
The World has Fewer Refineries Now
Due to the crash in demand during the last two years, refineries across the globe utilized the opportunity to permanently shut down older and less profitable plants.
There are fewer refineries now than in the pre-pandemic times. According to JPMorgan Chase, during the pandemic, approximately 3 million barrels a day of refining capacity were shut globally, with 33% of that, or around 1 million barrels a day, being closed in the U.S. itself.
Additionally, the refineries suffered tremendous damage from the hurricane in the Gulf of Mexico. While some companies are performing maintenance on their refineries, not all the oil stalwarts are keen on bumping up their capacities yet.
The underlying reason for their reluctance to increase capacity is the flattening of overall fuel demand in the U.S. and globally before the pandemic began, due to the imminent shift in the energy transition towards cleaner sources of energy and net zero. Many refineries, however, are converting their existing facilities into renewable fuel facilities.
Furthermore, increasing capacity comes at a significant cost, and it can take 20 years to recover the investments made. According to consulting firm Turner, Mason & Co., another 1.69 million barrels of U.S. refining capacity is expected to close by the end of 2023.
It is a win-win situation for oil companies, at least in the short-term. Higher prices are pushing profit margins to record highs for the oil companies. According to consultant RBN Energy LLC, the margins for producing gasoline on the East Coast spiked to more than $100 a barrel in late April and are approaching $50 a barrel, compared to under $10 a barrel in the spring of 2020.
The Russia-Ukraine War
To make matters worse, Russian refineries have been forced to shut down 800,000 barrels a day of capacity and potentially as much as 1.4 million barrels a day in May due to sanctions, according to JPMorgan Chase.
Likewise, there is an unavoidable shift in the European nations who now look to the U.S., Asia, and the Middle East to fulfill their oil needs. This is putting incremental pressure on an already tightened oil market, especially in the U.S.
Consequently, U.S. diesel fuel inventories dropped to their lowest levels in 17 years, drawing at a time of year compared to flat or building inventories under normal circumstances. According to the EIA, the U.S. inventory of gasoline is at 18.8 million barrels, which is 8% lower than the average for this time of year.
Furthermore, storage levels of diesel fell to their lowest level in its 40-year history in May.
The U.K. Tax Perspective
The newly introduced energy profits levy, imposed by the U.K. government, adds another twist to the oil story.
Last week, the U.K. government announced that it would impose a temporary levy of 25% on oil-and-gas producers, calling it a “windfall tax,” effective immediately. The government aims to help mitigate the effect of rising oil prices on consumers.
The extra 25% surcharge on top of the existing 40% tax rate on the energy industry’s earnings is expected to eventually phase out as oil-and-gas prices stabilize, but it may remain applicable until the end of 2025.
During the first 12 months, the U.K. government is expected to raise about £5 billion, or $6.3 billion at the new rates.
On the contrary, only last month, the U.K. government tried to incentivize oil and gas companies to spend more by announcing a new “investment allowance” of 80%, which is similar to a tax credit.
Oil Stocks Analysis
It is a win-win situation for oil companies, at least in the short-term. Higher prices are pushing profit margins to record highs for the oil companies.
Lets take a look at two leading oil stocks that could offer attractive long-term investment oppurtunity
BP p.l.c. (GB:BP)
Based in London, BP is a leading global integrated oil and gas company that explores, produces, and refines oil around the world.
Notably, BP shares have gained almost 40% over the past year, massively outperforming the benchmark indices.
Overall, the stock has a Strong Buy consensus rating based on 10 Buys and three Holds. The average BP price target of GBp498.46 implies 13.4% upside potential from current levels.
BP scores a 9 out of 10 on TipRanks’ Smart Score rating system, indicating that the stock has strong potential to outperform market expectations.
Shell (UK) (GB:SHEL)
Headquartered at Shell Centre in London, Shell is an integrated oil and gas company that explores produces and refines oil around the world.
Markedly, Shell shares have surged more than 75% over the past year, massively outperforming the benchmark indices.
Consensus among analysts is a Strong Buy based on 11 Buys and one Hold. The average Shell (UK) stock forecast of GBp 2,685.54 implies 11.69% upside potential to current levels.
TipRanks data shows that financial blogger opinions are 100% Bullish on SHEL stock, compared to a sector average of 76%.
Bottom-Line
Fuel demand will remain unabated in the coming months with more people taking road trips.
Clearly, there is a shortage of enough refining capacity to match this pent-up demand. The supply bottlenecks have been further heightened by the war situation and the western sanctions on Russia.
Most importantly, the ongoing COVID-19 lockdowns in China are keeping the global fuel demand in check. Once the situation normalizes in China, there will be incremental demand emanating from the region, further tightening an already choked-up supply situation.
On top of that, the Atlantic hurricane season is projected to be more active than usual this year and is capable of doing further damage. Any more refinery shutdowns or disruptions could stifle, supply making the U.S. dependent on fuel imports, thereby pushing prices higher.
By force of circumstance and the above-mentioned factors, the prices may continue to escalate in the months to come making both BP and Shell attractive Buys.
Meanwhile, the refineries, especially in the U.S., will continue to post record, all-time high margins, unless the U.S. government imposes a levy similar to the one announced by the U.K. government last week.
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