Why JPMorgan’s Pinakin Parekh Expects Oil Price Rally To Be Different This Time

A worker pours extracted crude oil for heating in the village of Wonocolo, East Java, Indonesia. (Photographer: Dimas Ardian/Bloomberg)

Why JPMorgan’s Pinakin Parekh Expects Oil Price Rally To Be Different This Time

Global demand for oil is expected to near pre-Covid levels by the third quarter of 2021 as economies open up following the pandemic’s second surge, according to Pinakin Parekh.

“Oil, unlike metals, is more driven by what happens in the U.S. and Europe,” the director of metals and mining at JPMorgan India and oil and gas analyst, told BloombergQuint’s Niraj Shah in an interview. As the two markets open up and, more importantly, as mobility increases, oil consumption will rise even as Asia and India are still coming out of the second wave, he said.

Parekh expects crude oil prices to reach the $80 a barrel by the year-end because of two forces: the strong near-term demand outlook and the medium-term uncertainty over what happens to oil prices if supply isn’t able to catch up.

Oil and gas explorers in India are at a place where metals were a few quarters ago, he said. “During the second half of 2020, steel prices had just started rising. China was also not going to drive demand, so it was believed these prices aren’t sustainable,” he said. “Hence, investors didn’t buy metals in the initial leg of the rally. As commodity prices moved higher, there was more demand visibility and the flow through equities happened.”

Parekh said he gets a “familiar sense” on oil when he speaks to investors. “Investors generally believe demand isn’t going to sustain, supply is going to surge and prices cannot sustain at these levels,” he said. “There’s a lack of belief or trust in the commodity price itself and hence investors don’t want to look at the commodity equity [upstream companies].”

Oil Prices May Remain High

A veteran of several commodity cycles, Parekh pointed out factors that made this cycle different—where oil prices would stay higher for long. “This is something neither the stocks nor investors are currently pricing in, leading to a potentially big positive inflexion.”

He said in the last six years, oil has thrice followed a boom cycle of 18 months, with prices rising to $75-80 a barrel. “Then you have a surge in supply from U.S. shale assets and prices fall back to $40. So, the general consensus is higher oil prices will attract higher supply,” he said. The difference this time is, shale is very clearly focused on capital discipline. Our U.S. team expects U.S. oil supply to increase by just around 600,000 barrels.”

The second factor, he said, is the lack of investment by global oil majors in new capacity. “This isn’t something that will change in the next 12-18 months since there are issues like ESG, which is asking for non-oil investment. This time, higher oil prices may not attract the same level of supply growth which we have traditionally seen.”

Tailwind For Ferrous Commodities

On the ongoing boom in metals and commodities, Parekh cited inputs from his China team that there’s little Asia’s largest economy can do to reduce prices. “They also highlight China is in a seasonally weak period of demand. The monsoon impacts construction and you might see a slowdown in demand. China selling from its reserves shouldn’t lead to a crash in commodity prices.”

Ferrous commodities, particularly steel, have a structural tailwind driven by China’s decarbonisation, he said. “Whether the current prices are sustainable are not, I can’t say but steel has a bigger structural tailwind compared to other non-ferrous metals simply because China is the largest exporter of steel in the world and if that supply reduces, it creates favourable prices.”

Parekh will wait to see the impact on Indian steelmakers even as many firms flaunt deleveraged balance sheets this cycle. “It will depend on what the new normal for commodity prices is. We’ll see how companies use their balance sheet strengths—do we see payouts, more judicious capex, higher ROEs. If you have these flow through, then there’s always a case for rerating.”

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