The energy sector has always been volatile. While the current geopolitical conflict in the Middle East is a headline-grabbing event, it really isn’t all that unusual. However, that doesn’t mean investors can simply ignore what is happening with supply and demand, given the region’s importance to the global energy market. Chevron (NYSE: CVX) is warning that things could get worse before they get better.
Brent Crude is the global oil benchmark. The geopolitical conflict has led to a swift, dramatic rise in the benchmark’s price, as you would expect. Recently, however, there has been a strange wrinkle in the market. Prices for oil to be delivered in June have been roughly $30 lower than the price for Brent Crude that will be delivered in the next 10 to 30 days.
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Wall Street is looking at oil prices further out, which may not fully reflect the supply/demand picture unfolding in real time. Essentially, the price difference indicates that the physical supply of oil is very tight in the energy sector right now. As such, buyers are willing to pay a high price to ensure they get the oil they need.
Chevron’s CEO is warning investors that oil prices aren’t fully reflecting the on-the-ground realities. The integrated energy giant expects higher energy prices in the near term as the supply/demand imbalance gets worse. The above dichotomy highlights why that could happen.
However, there’s another little wrinkle here. Countries and companies usually maintain a stockpile of oil, replenishing it as needed to keep operations running smoothly. The stockpile acts as a buffer because you can’t perfectly time deliveries. That is a problem right now because stockpiles are being depleted and supply is dramatically reduced, making it harder to replenish. That’s why oil company customers are paying a premium for near-term deliveries, as noted above.
Given that 20% of the world’s oil and natural gas flow through the Middle East, it is entirely possible that stockpiles fall to precarious levels. And that could lead to even more dramatic price spikes in oil and for the products that are made from oil.
There’s no way to know what will happen from here with the geopolitical conflict, but even after it ends, the energy sector will take time to return to normal. In other words, the supply/demand imbalance could get worse before it gets better. And still, most long-term investors should err on the side of caution with a diversified, financially strong company like Chevron, which is clearly preparing to handle the worst-case scenario that Wall Street isn’t pricing in just yet.