Investors in Energy Markets Receive Compensation for Maintaining Steady Nerves

Energy prices and energy stocks have been moving in different directions in recent months, but it's unclear which way the wind will blow next.

Benchmark Brent crude has fallen to around $80 a barrel, having averaged $101 in 2022. The outlook for oil demand has weakened due to China's messy reopening after almost three years of Covid-19 restrictions and the prospect of a global recession caused by rising interest rates.

Natural gas prices have been relatively stable so far in 2023. Wholesale natural gas prices in northwest Europe are currently around €70 per megawatt hour. This is similar to the levels seen before Russia invaded Ukraine, and a significant drop from the €350 high seen in August. The European Union was building up its gas storage at that time, after the Kremlin cut pipeline flows. However, unusually warm weather has meant that gas storage facilities in the region are now 83% full. This should help to ease any concerns about gas supplies for the remainder of the heating season.

Even though energy stocks have been volatile lately, they are still flying high. In the past two months, the likes of Shell SHEL 3.19%. BP is a British multinational oil and gas company with headquarters in London. The company has operations in over 70 countries and employs around 74,000 people. BP is one of the world's largest oil and gas companies, with a daily production of around 3.8 million barrels of oil and 10.9 million cubic feet of natural gas.

European markets have given up some of last year's striking outperformance, but they haven't followed oil and gas prices south.

Generous share buyback programs are one reason for the recent increase in free cash flow among European energy companies. According to brokerage Bernstein, last year free cash flow reached $141 billion, almost twice 2021 levels. As a result, energy companies boosted dividends and announced buybacks worth $42 billion, compared with $9 billion a year earlier. Shell, which accounts for close to half of this total, is currently buying around 20% of its daily traded volumes.

The companies' generosity can only continue while they are making more money than usual. This may ultimately boil down to a bet that the lull in energy prices will be temporary.

Europe will soon need to replenish its gas storage facilities for another winter, without the Russian pipeline flows it relied on before the war. Even with healthy levels in storage, the region will have to pay a premium over Asian buyers to attract seaborne LNG cargoes. Big Chinese buyers, which bought 20% less than normal last year, are expected to return to the market as the country fully reopens. Global LNG supply is expected to remain tight, with meaningful new production not expected until 2025.

The Kremlin has banned sales of oil to countries that comply with the recently imposed G-7 $60 cap on the price of Russian oil. This move could trim global supply by up to 7%.The Biden administration is also expected to begin refilling the Strategic Petroleum Reserve this year. However, Washington's ambition to pay below the current market rate could mean it moves slowly.

A peace agreement that ends tensions between Moscow and Kyiv and returns Russian oil and gas flows to normal would upend the current situation, but that looks far-fetched for now. The big risk to today’s bullish consensus is therefore that the macroeconomic news will get steadily worse, eventually forcing producers to rein in buybacks. Fourth-quarter results may offer some clues, but there will be plenty of other indicators to watch as well. Owning energy stocks this year will require constant macroeconomic monitoring.