Should oil patch investors be worried that recent gains will soon be undone? Certainly, there is a case to be made, but on balance the major slide from mid-2014 through February is likely over.
The two major issues in the energy market are the recent agreement by OPEC and the desire by the incoming Trump administration to attain energy independence for the U.S.
OPEC is still shaking. The OPEC agreement comes months after crude prices hit a multiyear low of $26 a barrel in February. That compares with more than $100 in mid-2014, and around $51 recently.
Energy patch stocks followed a similar roller-coaster ride. The Energy Select Sector SPDR exchange-traded fund (ticker: XLE) hit a recent low of $52 in January, before rebounding to around $75. The ETF holds a basket of energy industry stocks including Exxon Mobil Corp. ( XOM), Chevron Corp. ( CVX) and Schlumberger Limited ( SLB). It has annual expenses of 0.14 percent, or $14 per $10,000 invested.
[See: Oil ETFs: 8 Ways to Invest in Black Gold.]
At least part of the rebound in the stocks over that period was investor anticipation that producers would eventually cut back, through an OPEC agreement or otherwise. It comes back to the adage, “the cure for low prices is low prices.”
Still, there did end up being a formal agreement that was announced in November.
“The OPEC deal has certainly boosted the expected price of oil in the short term, or perhaps better said put a floor in at above $40,” says Bill Stone, chief investment strategist at PNC Asset Management Group.
So, don’t expect the price of crude to drop below $40 in the near future.
OPEC is still shaky. Just like all cartels, OPEC is unstable. That’s because each member country has an incentive to cheat by pumping more oil than it said it would. It’s a variation on the prisoner’s dilemma that individual cheating makes sense, but collectively it hurts.
Because of that inherent instability, expect what Stone refers to as supply “leakage” to manifest as production exceeds the agreed levels.
That extra output can be hard to identify because the oil market is nothing if not murky. Still, it will likely mean higher production levels than those announced.
Energy independence. One of the things that President-elect Donald Trump has suggested is that the U.S. should attain energy independence. Such a situation would mean that the country wouldn’t need to import oil from overseas.
It’s something that Continental Resources CEO Harold Hamm says could be achieved quickly.
One of the worries is that more supply from the U.S. means more supply worldwide, and would tend to push prices lower than they would be otherwise. That concern may be overblown because energy independence doesn’t necessarily have to be a tsunami of additional oil.
“I wouldn’t agree the energy independence would cause a global oil glut,” says Thomas McNulty, director at Navigant Consulting in Houston.
He says that improved efficiency of the drillers in North America means that production can be turned on and off very quickly on wells that have been idle for a while. Idle wells don’t tend to degrade in the way that idle mines do.
Better still, the oil industry is far more efficient than it was just a few years ago. “Fracking was revolutionary and even that has gotten better efficiency,” he says. “For example, if it used to take six months to get a well going again, now its two months.”
And as more drilling is done, more efficiencies will be squeezed out of the operations.
[See: The Best Energy Stocks to Buy for 2017.]
So what? The U.S. might not need to constantly produce crude oil in order to have energy independence. Instead, the wells could simply be available to turn on depending on the need for additional crude.
As with many things that involve the incoming administration, little is clear about how near the top of the agenda energy independence will come.
“For 2017 the biggest issue is policy uncertainty,” says Charlie Ripley, investment strategist for capital markets and trading, at Allianz Investment Management in Minneapolis.
Investment implications. The overall news for the energy industry is positive, but that doesn’t mean all oil stocks will do well.
“Oil companies and their stocks don’t always trade in lockstep with oil prices,” says Stephen Wood, chief market strategist, at Russell Investments. “There may be idiosyncratic factors that can influence any specific oil company — and its share price — that may not be directly related to the price of the commodity.”
The idiosyncrasies could include pipeline accidents, tankers leaking, terrorist attacks on foreign operations or management failures.
[See: 10 of the Worst Performing Stocks of 2016.]
That probably means that buying specialty mutual funds or ETFs would be less risky than individual stocks.
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Will the Trump Administration Sink Crude Oil Prices Again? originally appeared on usnews.com
