Oil prices have been reeling ever since OPEC+ talks collapsed due to major disagreements by its members. Major cracks appeared in the ministerial meeting with the United Arab Emirates continuing to block an agreement because it wants to increase its oil production before demand falls as per WSJ. The market fears that the UAE might "want out of OPEC so it can pump 4M bbl/day and make hay while the sun shines," Phil Flynn, market analyst at Price Futures Group, has told MarketWatch. 

But, somehow, the oil price outlook keeps getting worse.

Fresh travel restrictions in Asia have just dashed hopes for a recovery in jet fuel demand this year and worsened the outlook for the entire refining sector due to a resurgence in COVID-19 infections.

Asia's worsening pandemic due to the Delta Covid-19 variant is expected to keep flights grounded and poses a serious challenge to refiners despite more encouraging trends in Europe and the United States.

Weak Jet fuel margins

"The persistent weakness in jet fuel cracks would definitely weigh on overall refining margins in Asia. There is a part of the jet pool that cannot be blended away elsewhere. And its poorer cousin, kerosene, sells for far less than jet,’’ Sukrit Vijayakar, director of Indian energy consultancy Trifecta, has told Reuters.

Whereas Asia was among the first regions to emerge from COVID-19 lockdowns in 2020, a fresh flare ups of new strains in recent months have forced several key destinations such as Japan, South Korea, Indonesia and Vietnam to tighten movement restrictions again.

To get an idea of how bad the Asian situation has become, consider that scheduled flight capacity in Japan was 55.6% below the corresponding week in pre-pandemic 2019 while capacity in South Korea, Australia and India were down 46.4%, 56.7% and 40.1%, respectively.

In sharp contrast, U.S and European aviation capacity have been recovering much faster, and therefore presenting refiners in those markets with a growing outlet for the fuels they produce.

Story continues

Refiners in Asia are saddled with growing quantities of excess jet fuel that they are unable to store for long periods thanks to a tendency to deteriorate in quality. That forces them to either sell to other regions or blend it into other lower-value fuels–at the expense of margins.

Thankfully, winter might provide a much-needed respite for Asai refiners.

Further, the jet fuel demand outlook is expected to improve by year end thanks to a successful vaccine rollouts as well as improving seasonal heating demand.

Overall, experts expect that should help lift Asian jet refining profits to $7-9 per barrel in Q4, from around the current $6-8 per barrel over Dubai crude.

Energy sector deeply out of favor

An even bigger reason to remain bullish: The energy sector remains deeply out of favor, and Wall Street has little choice but to bite sooner or later given the sector’s stellar performance compared to other market sectors.

"I've had a lot of calls with institutions over the last couple days and I'll tell you that most institutions are extremely “underweight” the energy sector. With this being the best performance for the energy names since 2005, they're going to have to buy them. They will not have a choice," Piper Sandler's Craig Johnson, the firm's senior technical research analyst, has told CNBC.

Johnson has recommended buying the XLE ETF outright or investing in individual energy stocks, highlighting top holdings ExxonMobil (NYSE:XOM) and Range Resources (NYSE:RRC).

We like Johnson’s picks and recently recommended XOM as a top dividend stock.

The United State's largest integrated oil and gas company, ExxonMobil Corp. (NYSE:XOM) is also one of the leading dividend aristocrats in the energy sector.

Exxon Mobil Corp has been named in the Dividend Channel ''S.A.F.E. 25'' list, signifying a stock with above-average ''DividendRank'' statistics including a strong 5.52% forward yield, as well as a superb track record of at least two decades of dividend growth.

Last quarter, Exxon reported that industry fuel margins have improved considerably from the fourth quarter but still remain below 10-year-lows due to high product inventory levels as well as market oversupply.

The best part: Cash flow from operating activities clocked in at $9.3 billion, managing to fully fund the dividend and capital expenditures as well pay down debt by over $4 billion.

Meanwhile, we have also recommended oilfield services companies (OFS) as drilling activity gradually picks up.

Oilfield services companies such Schlumberger, Halliburton (NYSE:HAL) , Baker Hughes (NYSE:BKR), and National Oilwell Varco (NYSE:NOV) are now reporting that prices for their services and equipment have bottomed out, and many are now recruiting new workers.

It's a clear sign that U.S. crude production is ticking back up after a very depressing period. Indeed, for the first time since the pandemic hit, U.S. shale output is expected to rise by 38,000 barrels per day in August despite generally flat spending by oil and gas producers.

While the Fed sees GDP growth moderating to 3%-3.5% next year from about 7% this year, that is still very strong growth when you consider that the U.S. didn't have a single year with 3% growth between the 2008 financial crisis and the pandemic.

The energy sector may be out of favor and trending on the “wrong” side of a climate change war, but the market is the market, and for now, it’s dictating that traditional energy stocks will still be the best performers, even if solar and wind had a nice run and investors are still doubling down. They’re in it for the long haul, but there’s a lot of time between now… and then. 

By Alex Kimani for Oilprice.com

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