Oil hovers US$110: US hedge funds load up energy stocks, China threatens demand

The S&P/ASX 200 Energy Index is keeping it together, up 0.02% at noon amid what is otherwise a painful day for the local sharemarket.

Oil prices are trying to head higher as investors fixate over the implications of the looming European sanctions on Russian oil. 

WTI Crude Oil (Source: TradingView)

“No one wants to be on the wrong side of a major crude supply disruption headline, so whatever oil price dips that happen will be short-lived,” said Oanda senior market analyst, Ed Moya.

The proposal requires all 27 EU member countries to agree to the embargo. However, Hungary, Bulgaria and Slovakia - all heavily reliant on Russian oil imports - have objected the embargo.

Meetings between EU leaders will continue this week as Russia-reliant nations negotiate an exemption for imports and/or a longer period to adapt to the embargo.

Countering the embargo's upside pressure to oil prices is China's covid situation.

Saudi Arabia cut oil prices for buyers in Asia for the first time in four months as Chinese lockdowns begin to weigh on economic growth, according to Bloomberg.

Last week, Chinese leaders doubled down on the current zero-covid strategy, sticking to punishing lockdowns even as economic activity rapidly deteriorates in April.

China enjoyed a five-day holiday last week in celebration of Labour Day. According to the Ministry of Culture and Tourism, tourist spending was down -43% year-on-year and domestic tourist drips were also down -30%.

Looking at the bigger picture, the International Monetary Fund lowered its China growth forecast to 4.4% for 2022, well below the government’s official target of 5.5%.

Thematic tailwinds

The underappreciated energy sector is beginning to see some love.

“Hedge funds bought US Energy stocks at the fastest pace since Mar ’20 amid continued sector outperformance. Energy now makes up 4.4% of overall US Net exposure (vs. 2.1% at the start of 2022), the highest level since Aug 19,” according to Goldman Sachs. 

Alongside the strong flow of funds, oil companies are choosing to give back record profits to shareholderes - instead of reinvesting into new production to help relieve current supply conditions.

Against that backdrop, investment in upstream oi and gas sector fell -30% in 2020, and down -23% in 2021, according to the International Energy Forum.

Food for thought

The shift away from Russian imports and lacklusture output capacity is bullish for oil prices. Though, China remains a key risk that could derail or cap oil's upside potential.

Its also worth considering the bearish state of the broader market. A bear market is taking shape in the US and the ASX has had some pretty hard hitting sessions in the past 2-3 weeks.

Local energy stocks could struggle to capitalise on any oil upside if the broader market remains in this vulnerable and bearish state.