As expected, the OPEC agreed to extend its current crude oil production cuts until March 2018, but the May 25 announcement still disappointed oil traders.
[See: Oil ETFs: 8 Ways to Invest in Black Gold.]
West Texas Intermediate crude oil futures at the New York Mercantile Exchange fell below $50 a barrel on the news, the lowest price in two weeks. Stocks of the major oil producers — like Exxon Mobil Corp. (ticker: XOM), BP ( BP) and U.S. shale producer Continental Resources ( CLR) — followed the sell-off. Since then, oil stocks and oil futures prices have held steady.
A persistent oil glut. OPEC members first agreed to cut daily production by 1.8 million barrels in November, and at last week’s meeting they decided to maintain those cuts through March 2018. Stewart Glickman, energy equity analyst for CFRA in New York, says energy markets fell because investors expected more than the status quo from the cartel.
“I think the (market traders) were hoping for a deeper cut, and when it didn’t materialize, they sold off,” he says. Glickman believes the Saudis are betting that the existing cuts will be enough to hurt U.S. producers.
For years OPEC sought to control oil prices, but then hydraulic fracturing came along and with it a surge in U.S. shale oil production. That forced OPEC to change tactics. In an effort to keep market share and strangle U.S. output, the cartel flooded an already glutted global supply with more oil in late 2015. As a result, oil prices crashed to multi-year lows, falling to less than $30 a barrel at one point. Although it succeeded in squashing U.S. production, OPEC also suffered from the crash. Oil prices have since risen to about $50 a barrel, but global inventories remain stubbornly high despite the cartel’s production cuts.
The thorn in OPEC’s side. One reason is that U.S. shale producers haven’t been deterred. In fact, once prices came off their lows, the shale producers began drilling again in the cheapest, most lucrative areas, like the Permian Basin in Texas. The U.S. Energy Information Administration predicts U.S crude oil production will average 9.3 million barrels a day in 2017, up from an estimated 8.9 million daily barrels in 2016.
Glickman says it’s likely OPEC and its biggest member, Saudi Arabia, are hoping that U.S. production will drop, which would help whittle away at the global oil glut. Although shale oil fields produce a lot of oil quickly, they decline fast, too. In a May report the EIA estimates a slight drop in the Permian basin’s daily output.
“It’s almost a war between technology and geology. If technology wins, inventories are not going to come down and OPEC is going to be boxed in,” Glickman says.
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Mike Ciccarelli, commodity and stock trader at Chicago-based Briefing.com, notes even with OPEC’s current production curbs, oil prices are not far from where they were when the cartel first embarked on its cuts, thanks in part to U.S. producers. But he wonders what will happen to oil prices beyond March, when the curb is curtailed.
“The main problem is by the time the first quarter comes around, we’ll be back in a glut,” he says.
Reasons for optimism. Portfolio managers at Tortoise Capital Advisors, which has $17.1 billion in energy assets, expect global oil inventories to return to historic norms based on OPEC’s latest actions. But they also believe shale oil production is here to stay and expect oil prices to range between $50 and $60 for some time.
“We believe we are moving into a new era of low-cost energy that could significantly boost global economic growth,” the managers reported in a recent research note. “We expect the winners to be the lowest-cost producers of energy commodities like U.S. shale.”
The U.S. oil and gas sector will slow down when prices dictate, says Michael Cohen, head of energy markets research at Barclays. The firms are still drilling where it’s most profitable. “At current price levels, many producers will continue to meet or exceed their 2017 production guidance,” he says.
Although energy companies are in a slump, with terrible year-to-date returns, things may be looking up.
CFRA just upgraded the exploration and production sector to market weight from underweight, even though the companies’ earnings power was slashed from where it was before prices crashed, Glickman says.
“I think we’re getting close to an inflection point, and a lot of E&Ps, in particular, don’t look that expensive right now, if you’re using 2018 estimates,” he says. “So, I’m a little bit more optimistic on E&Ps than I had been.”
To hold long term, Ciccarelli has a few companies he would buy on price dips. He likes Exxon, U.S. Silica Holdings ( SLCA) and Pioneer Natural Resources Co. ( PXD), which, he says, are the strongest of their peers.
[See: The Best Energy Stocks to Buy for 2017.]
Energy investors should avoid speculative names and take a good look at the companies’ balance sheets, Ciccarelli says. “You want to look for good, quality names right now.”
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Has OPEC Set the Stage for an Energy Rebound? originally appeared on usnews.com
