Oil prices are showing signs of life, rebounding from their unprecedented dip below zero this spring. Coronavirus vaccine breakthroughs are sparking hope for a return in demand for jet fuel and gasoline. And a blue wave did not materialize during the November election, easing fears of a fossil fuel crackdown from Washington.
That scenario is persuading investors to pile into beaten-down oil stocks. During Wall Street's blockbuster month of November, six of the top seven S&P 500 stocks were in the oil industry. Occidental Petroleum (OXY) spiked by a stunning 73%. Devon Energy (DVN), Apache (APA) and Diamondback Energy (FANG) climbed by more than 50% apiece.
The Energy Select Sector SPDR ETF (XLE) rallied 28%, the second-strongest month since the fund launched in 1998, according to Refinitiv, narrowly missing the record set in May.
"Christmas came early for the oil-and-gas industry," said Bob McNally, president of consulting firm Rapidan Energy Group.
'Mother-of-all gut punches'
The resurgence makes sense given that US oil prices climbed 27% in November, marking one of the best months ever. (The record was set this past May when crude spiked 88% after crashing below zero the month before).
The vaccine announcements by Pfizer (PFE) and Moderna (MRNA) set off a rush on Wall Street to buy pandemic losers, including small-cap stocks and cyclical sectors such as energy.
"When people want to put on risk, they go to the most beaten-up sectors first," said Daryl Jones, director of research at Hedgeye Risk Management. "Energy was the most washed-out sector."
For context, despite the epic rally in November, the energy sector is still down nearly 40% this year. ExxonMobil (XOM), the largest US oil company, has lost almost half its value in 2020.
The pandemic set off an unprecedented collapse in energy demand, with millions of Americans stuck at home. Energy profits plunged, job cuts mounted and share prices cratered.
"For the oil industry, Covid was the mother-of-all gut punches," McNally said.
The hope is that highly effective vaccines, once distributed, will encourage more mobility. And more people flying and driving is a prerequisite for a full recovery in the energy industry.
But the energy rally isn't solely about vaccines and reopening the economy.
No blue wave
Investors are also breathing a huge sigh of relief that Democrats failed to sweep the election -- an outcome that looked to be in the cards just a few months ago.
A blue wave -- on top of a pandemic -- would have been disastrous for the oil industry because Democrats vowed to ramp up regulation to fight the climate crisis.
"That's not dodging a bullet," McNally said. "It's dodging a cannonball right at their head."
If Democrats had taken decisive control of the US Senate, they would have been primed to pass sweeping climate legislation. The biggest threat to Big Oil would have been stripping tax breaks from the fossil fuel industry.
"The stars were aligned to take a bite out of the oil-and-gas industry's balance sheet. That now goes away," said McNally.
Even if Democrats sweep both run-off races in Georgia next month, control of the US Senate will be a 50/50 tie, with Vice President-elect Kamala Harris breaking any stalemates.
Drilling restrictions ahead?
That's not to say the oil industry is completely out of Washington's crosshairs.
President-elect Joe Biden can sign executive orders that will make life difficult for oil companies. During the campaign, Biden explicitly opposed a nationwide ban on fracking, the controversial oil-and-gas drilling technique that climate activists want to shut down. (Harris, during her presidential run, favored a fracking ban.)
Biden has proposed a more moderate step: banning new oil and gas permitting on public lands and waterways. But Biden does want to achieve net-zero emissions by no later than 2050, a goal that would all but require a significant drop in fracking.
And then there's OPEC. The crash in oil prices this spring was partially driven by the price war between Saudi Arabia and Russia.
OPEC and Russia teamed up to enact unprecedented production cuts that successfully revived the market. But that alliance is shaky and OPEC is struggling to decide when to start pumping more. The group was unable to reach a deal Monday, delaying a decision until later this week.
If the OPEC reductions unravel, it would put renewed pressure on crude prices and oil stocks.
The rise of ESG
Bigger picture, the oil industry still has a massive climate problem, one that can't be solved by OPEC, vaccines or the election.
With the rise of ESG (environmental, social and corporate governance), investors are putting a premium on companies viewed as solutions to the climate crisis (such as Tesla (TSLA) and solar companies). And they're penalizing ones that are seen as part of the problem.
For Big Oil, that means weaker valuations, higher borrowing costs and continued pressure from shareholders pushing them to decarbonize.
"It's not smooth sailing ahead," McNally said.
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