Energy Stocks Surge on Positive Vaccine News
But plenty of upside remains.
Energy stocks surged on Nov. 9 following Pfizer's announcement of favorable phase 3 data on its COVID-19 vaccine. The broader Morningstar U.S. Market Index was up 1% on the day, but the energy sector soared 14%. West Texas Intermediate oil prices were up about 8%. Despite the rally, the energy sector is still down around 45% year to date. We think the sell-off has been overdone, and as such, energy stocks continue to look undervalued overall. Our median covered energy stock trades at a 37% discount to our fair value estimate. Within energy, oilfield services look cheapest overall, trading at a median 52% discount to fair value. Exploration and production stocks trade at a median 45% discount to fair value.
We agree that a vaccine is crucial to energy stocks, although we had already expected one or more successful vaccines to be deployed in the first half of 2021. Once broad vaccination occurs, most economic activity has the potential to return to normal. Not only will this spur a broad recovery in GDP, but we also expect the ratio of oil demand to GDP to essentially recover to prepandemic levels. Altogether, this will make for a near-complete recovery in oil demand to our prepandemic expectations.
With oil demand set to stage a strong recovery, more supply will be needed. Yet global drilling activity has collapsed along with oil prices in 2020. Unless drilling activity rises from bare minimum levels, the supply response will be insufficient and the glut will become a shortage. Significantly higher crude prices are necessary to encourage this, but the market is still extrapolating bottom-of-the-cycle crude prices to infinity. Our midcycle oil price forecast is $55/barrel WTI, far higher than the current price of $40/barrel or even futures dated 2023 at about $44.
As of October, global oil demand was still lagging by about 8% versus 2019 levels. The hit to oil is exceeding the drop in overall economic activity, especially because air travel/jet fuel demand has been disproportionately hit. Also, many workers are still working from home rather than commuting to the office, reducing gasoline demand.
Once a vaccine is available, however, we expect a very strong recovery in global air travel, in line with Morningstar's travel analysts. 9/11 is an instructive episode: While the fear created by the attacks had a temporary depressing effect on air travel, that effect faded over time and eventually air travel more or less fully recovered.
In addition, we think that most workers will return to the office, as only a small share of workers are cut out for working from home in the long run. Working from home requires the confluence of the right occupation, permission from the employer, and ultimately choice of the worker. We estimate only 13% of the U.S. workforce will clear all three of these hurdles, making for only a modest uptick in work-from-home adoption versus prepandemic levels.