Are we in an energy supercycle?

The Ukraine war has been raging for nearly two years.

Whilst the Russo-Ukraine conflict has in fact been going on since 2014 it was 22nd February 2022 when we really saw an escalation, with a full-scale invasion by Russian troops. By June of the same year, Russia occupied close to 20% of Ukrainian territory, the U.S. and Europe had escalated sanctions and markets were struggling to understand what this all meant.

Immediately following the outbreak, energy prices shot up worldwide, reaching a 20% increase for five months straight. WTI rose from $92.77 per barrel on 24/02/22 to an average of $106.96 (+15.3%) between 28/02/22 and 02/08/22. However, since then, there has been significant flux (down as far as $69.77 on 23/03/23 and up to $93.67 on 27/09/23). At the time of writing WTI is hovering around $82.5 per barrel.

Many media outlets prompted this to be the beginning of an energy supercycle. But was it?

Whilst the conflict has no doubt had an impact on energy prices, causing significant volatility, it is only one of a number of shocks over the past few years and in its own right is just one, albeit a momentous, event.

Before we go further, let's understand the factors typically associated with an energy (or commodity) supercycle:

• Demand: Growth in demand. For example, as emerging economies continue to industrialise, social mobility is leading to a growing, product-hungry middle class. Demand for oil in particular continues to rise, powering factories, vehicles, plastics production and more
• Supply: in certain commodities, such as oil, supply can be adjusted, but only by a relatively few number of major economies with well-developed supply chains such as the UAE and the U.S. Furthermore, production shifts take time to filter through. Whilst other smaller economies form a significant part of the supply chain, geopolitical unrest, such as we've seen in Ukraine and more recently Israel, can have a destabilising effect
• Price: When demand outstrips supply we typically see higher pricing. But this isn't where the story ends. Price spikes in their own right often lead to a period of contagion as investors become attracted to growth markets, potentially leading to bubbles, where price becomes disconnected from the original supply/demand dynamic
• Other factors: inflation, currency shifts, technological advances (such as the shale revolution in the U.S.), regulation (including pressure for more renewables) and investment in supply can also have significant impacts

But are there enough of these factors to qualify for a supercycle?

Dave Ernsberger, Head of Market Reporting & Trading Solutions at S&P Commodity Insights doesn't believe so: "A multiyear supercycle requires three indicators: Is supply surging? Is demand surging? Are prices surging? Without passing all three tests simultaneously, commodity markets are not in a supercycle". He goes on, "Demand is surging for commodity markets as a whole; demand growth has been underwhelming for most transport fuels, while sustained increases in demand are likely to be challenged by momentum building in recessionary sentiment. Supply is not surging either". In Ernsberger's view, the significant market uncertainty has also led to investors shying away from longer-term infrastructure investment in the sector.

However, some analysts remain bullish. Christyan Malek, Global Head of Energy Strategy at J.P. Morgan predicts >$150 per barrel by 2026 led by “institutional and policy-led pressures” as countries move away from hydrocarbons. Whilst Malek points to the Organisation of the Petroleum Exporting Countries’ (OPEC) ability to affect supply through subsidies in the short term, he has a broader concern regarding longer-term supply issues leading to persistent price rises over the years ahead. "Oil CapEx has never been so far back in the queue", he says, aligning with Ernsberger and pointing to a particular lack of investment. This has fuelled his concern that whilst few can argue renewable investment is good, it simply won't fulfil demand in the short to mid-term. This can only lead to higher prices.

So where does this leave us?

On a macro scale, many of the ingredients for a supercycle remain: (i) continued population growth - approaching 8 billion (ii) low commodity/equity ratios - often sparked by poor economic growth and high inflation (iii) struggling supply chains partly due to the hangover from COVID-19.

What about the Israel-Hamas war?

It's not quite clear just yet what long-term impact this may have, however Indermit Gill, the World Bank’s chief economist has raised concerns: “The latest conflict in the Middle East comes on the heels of the biggest shock to commodity markets since the 1970s — Russia’s war with Ukraine". A swift resolution may mean prices of $85-95, however, contagion is a significant risk in an area of the world where oil is highly politicised. A major disruption could easily see prices surge beyond the $150 figure that J.P. Morgan has mooted in a much shorter time horizon. The impacts of this will be more severe on Europe, given the U.S. reserves and the growth of shale. What is clear is that reliance on hydrocarbons is a major concern.

In summary, it's important to separate short-term shocks and longer-term trends. As the chart below shows, between 1986-2000 oil prices remained relatively stable but have seen huge shocks since, including (i) the 2008 financial crisis, (ii) COVID-19 (iii) the Ukraine war and now (iv) the Israel-Hamas conflict. Whether the market will find a 'new norm' is still to be seen, but until there is a significant shift away from hydrocarbon-based economies it is hard to see that we're not at the beginning of a longer cycle.