After Wild 2020, Here's A Variety Of Energy Commodity Considerations For 2021

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Volatility is a nightmare for investors, but it creates a paradise of opportunities for traders with their fingers on the pulse of markets. 

The incoming Biden administration has pledged to shift US energy policy towards a greener approach to powering the nation and the world. The regulatory environment will become a lot stricter as it moves from four years of the drill-baby-drill and frack-baby-frack policies of the Trump administration to supporting alternative power sources that do not include fossil fuels.

Less fracking and higher regulatory costs are likely to cause US oil and gas production to decline over the coming years. The Jan. 5 runoff elections in Georgia will determine how far the incoming administration can go when limiting hydrocarbon output as it will determine the balance of power in the Senate. A victory by Republicans would set the stage for negotiation and compromise, and could restrict the green agenda.

If, however, Democrats capture both Senate seats, it will give the Biden administration clear sailing for its initiatives, making the energy policy shift more dramatic. In any case, President-elect Biden will rejoin the Paris climate accord, and fossil fuel production is likely to decline from levels seen over the past years.

In March 2020, US crude oil output rose to a record level at 13.1 million barrels per day. We are not likely to see production return to that level in the foreseeable future. As Russian and Saudi Arabian production rises above US output, the pricing power could tilt back to OPEC+. The cartel members want crude oil prices at the highest possible level.

For decades, US energy policy was to achieve independence from foreign oil. As regulations increase, the decline in production could cause increasing dependence on OPEC+ as crude oil is still a critical energy source in the US and the world. LNG remains a growing business in natural gas that could siphon off US supplies if the new production environment impedes output. 

The low oil and gas prices in 2020 were a function of demand evaporation because of the global pandemic. As people worldwide worked from home, limited travel, and practiced social distancing, the need for energy declined, sending WTI crude oil to an all-time low and natural gas to its lowest price since 1995.

Vaccines that create herd immunity could cause a sudden spike in demand for energy as people escape the confines of homes, return to offices, and take those long overdue vacations. OPEC+ cut production in 2020 by a record amount. The cartel will continue to taper its cuts, but a US energy policy shift may offset any increases from the cartel over the coming months and years.

After the demand evaporation of 2020, the coronavirus’s aftermath could create a demand surge in 2021. 

The worldwide financial landscape supports higher commodity prices. The US dollar index declined from the highest level since 2002 at 103.96 in March 2020 to below the 90 level at the end of the year, the lowest level since 2018. The dollar is the world’s reserve currency and the pricing mechanism for most commodities, including energy. A falling dollar tends to support higher commodity prices.

Moreover, the monetary and fiscal policies of central banks and governments remain highly accommodative. A tidal wave of liquidity in the form of low short-term interest rates and quantitative easing programs that depress rates further out along the yield curve stimulate borrowing and spending and inhibit saving. Monetary policies lower the carrying cost for commodity inventories. Simultaneously, the shift in Fed policy from a 2% inflation target to a 2% average encourages inflation, which is bullish for raw material prices.

Government stimulus programs increase deficits and the money supply. Central bank liquidity also causes the money supply to expand. The world financial system planted many inflationary seeds in 2020 that are likely to bloom in the coming months and years. While the 2020 pandemic was far different from the 2008 global financial crisis, central banks and governments utilized the same tools to stabilize the worldwide economy. From 2008 through 2011, commodity prices rallied to multi-year, and in some cases, all-time highs. If history repeats, we should expect the same price action in raw material markets over the coming years.

From a political perspective, US energy output will decline under the Biden Administration. The Middle East is still home to over half the world’s crude oil reserves. The assassination of Iran’s top nuclear scientist in late 2020 highlights the Middle East’s turbulent political nature. Moreover, as Israel and many Arab nations have strengthened ties, the gulf with Iran widened. Any increase in hostilities in the area that impact production, refining, or logistical routes could cause short-term price spikes in crude oil futures markets. Nothing drives the price of oil higher, like a supply scare.

As we move into 2021, the political and financial landscapes for commodities are the most bullish in years. Bull markets rarely move in a straight line. Buying commodities on price dips over the coming weeks and months could be the optimal approach to the asset class for the coming year.

Crude oil and natural gas prices are likely to continue to experience lots of volatility in 2021. We will not have to wait long for the first significant event of the new year. The Jan. 5 elections in Georgia will determine the extent of the shift in US energy policy. However, it is always the unknown that tends to cause the most substantial price volatility.

In 2020, it was the pandemic that came out of the blue. In 2021, an event we have yet to consider—and which may still not be on our radar—is likely to be the factor that causes the most price variance. 

Written By: Andy Hecht