I don’t want to spend too much time today rehashing the big macro picture. But oil prices are back in the headlines. And to understand why, we need to spend some time talking about geopolitical matters first.

As you may recall, the focal point of the last price spike was Vladimir Putin’s weaponization of energy across Western Europe. That upheaval is still ongoing. Just recently, President Biden made a strong appeal to the UN General Assembly, asking for Ukrainian support.

Meanwhile, on the supply side, we know about the stingy Russian oil exports (now at a 12-month low). OPEC has also throttled back on production yet again, this time slashing output by 1.3 million barrels per day. The cartel recently agreed to extend those cuts through the end of the year to keep supplies tight and prices firm. Predictably, the announcement triggered an immediate response from traders.

Now, I’ve been following the energy beat for a long time. So I don’t want to diminish the geopolitical angle. I know it’s a big reason why we’re up close to 200% over at Takeover Trader.

But geopolitics aside, there are compelling reasons why the energy sector has the highest percentage of bullish analyst buy ratings (64%) of any market group right now. For starters, the steep decline in oil consumption during the pandemic lockdowns is now just a short-lived blip on the charts. The world is thirstier than ever, with usage rebounding to a record 102 million barrels per day this year. The International Energy Agency is forecasting that total will climb by another million in 2024, bolstered by rising demand from the petrochemical and aviation sectors.

We could talk at length about the impact of busier air travel alone. There are roughly 100,000 passenger and cargo departures daily – and none of those jets run on batteries.

But there is a much bigger issue that we need to talk about in order to understand why I think prices are likely to stay elevated for some time.

A Gap In Capex Spending

Years of under-investment are coming home to roost. The ranks of oil producers have thinned considerably following more than two hundred bankruptcies over the past seven years. As for the rest, capex spending simply hasn’t tracked cash flows.

Pioneer’s (NYSE: PXD) CEO Scott Sheffield has pinned a number on the problem: $1 trillion. That’s the cumulative gap in global spending since 2015 below what was prudently needed for oil output to keep pace with demand.

I believe there are two root causes. First, steep down-cycles in 2014 and 2020 acted as a deterrent, discouraging large-scale exploration and development activity. There has also been an industry-wide shift prioritizing capital returns (dividends and buybacks) over raw production growth.

Keep in mind oil reservoirs are constantly depleting. It is a challenge for large producers just to maintain output, let alone ratchet higher. ExxonMobil (NYSE: XOM) has earmarked $24 billion in capital expenditures on “high return” projects this year to keep daily output level. But management has set aside $30 billion for dividends and buybacks.

With few exceptions (like Saudi Arabia and the United Arab Emirates), most of the larger producing nations have reached a plateau and have little to no spare capacity to bring more supply online. And U.S. shale basins can only pick up so much slack. That has all given rise to headlines like these.

Is the World Sleepwalking into an Oil Supply Crunch?
— Forbes

OPEC+ Output Cuts to Deepen Oil Supply Deficit, Risk Higher Prices
— S&P Global

Oil Price Exceeds $95 A Barrel on Fears of Supply Shortfall
— Financial Times

That last one (dated just last week) beat me to the punch. Benchmark oil prices have spiked 30% since June and are now flirting with the $100 level. Brent peaked at $95.96 per barrel a few days ago.

And consider this: domestic oil stockpiles at Cushing and other storage hubs have been drawn down for five straight weeks.

The Strategic Petroleum Reserve (SPR), which was brimming with 638 million barrels in 2021, is now half-empty. As you may know, The White House drained millions of barrels last year as a short-term fix to ease gas prices (and some would say score political points). That has left the SPR near record lows, heightening the risk of a major hurricane or other supply disruption.

Closing Thoughts

Put it all together, and you can see why forecasters like Goldman Sachs envision a scenario where prices could climb to $107 per barrel next year. Many efficient producers are tightening their belts and lowering breakeven levels to $30-$40 per barrel. So the industry will be gushing cash flows at these prices.

That’s one of the reasons why I have consistently named Pioneer Natural Resources (NYSE: PXD) as one of my favorite ways to profit. And as much as I still like PXD, there’s a pick we think has even more upside…

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