Oil stocks are finding some strength this week, even as oil prices remain under $50 a barrel. I see investors again trying to pick a bottom on oil stocks. I say that these efforts are, for now, doomed to fail, as the full brunt of the shale bust has yet to be felt.
I understand the hopes of investors who have poured money into oil stocks this week, even though oil prices remain low. I could make the case myself that oil stocks have vastly underperfomed the Standard & Poor's 500 Index and are due to have their day. Production numbers for the week are slightly down for the first time in many months, perhaps indicating that the slashing of rig counts is finally translating into the drops in production necessary to end the crude price slump. Finally, the dustups in the Middle East, from the Saudi military activity in Yemen to the ever-more troubling extensions of the Iranian negotiations, seem to point to a moment to shift back into oil. But I say not yet.
Not that I think that oil is going to again breach the low $40s in price. There is a market theory of a crude "clearing price," where oil finds buyers and less traditional routes to move out of glutted areas no matter what the fundamentals of supply and storage might say. I think that is right, and the idea of low $30s targets on oil, or low $20s as Citibank has called for to be downright ridiculous. But it is equally ridiculous to think that oil can again rally into the profit zone above $60. Production does matter, and we are at the limits of traditional storage. Further, if the exploration and production companies haven't collectively lied in their recently quarterly presentations, production is definitely going up this year. Finally, dozens of oil companies could buy themselves another year or two of life should they be able to sell financial futures anywhere near $65 a barrel. That means a wall of real commercial selling should oil rally. I don't think it will.
With oil stuck in this $45-$55 area for the next several months, we'll still need to see a lot more consolidation, defaults and outright bankruptcies. Most of the oil stocks I am modeling are pricing today based on $75 oil, including even the best financed ones I love, such as EOG Resources (EOG), Cimarex (XEC) and Anadarko (APC). I admit to having a core position in two of these, having recommended EOG under $90 and Cimarex as it was trading closer to $100. But I cannot add to them now, with crude priced at a level I don't think we can see until at least the second quarter of 2016.
In a stock market that is calling for a sector shift -- as I think this one is -- the natural tendency is to reach for the underperforming sector, which is oil. I cannot deny this instinct and instead have tried to circle back to the big integrated names for starting fresh positions the last few weeks. I have concentrated on companies with solid downstream storage and refining assets, and, if possible, on foreign companies to take advantage of a dollar arbitrage that I think is coming. Interesting to me are Royal Dutch Shell (RDSA), Canadian oil behemoth Suncor (SU) and French giant Total (TOT).
I understand the fear of missing the next great oil boom that many investors believe (correctly, in my view) is coming. But now is not the time and these are not the levels to bet on high-beta oil names. It's still wiser to wait it out in larger-cap integrateds until more blood in U.S. shale players is spilled. And with oil staying in this range for several more months and for perhaps quarters to come, that blood is still to come.
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