The entire oil sector has experienced a relief rally over the past few days as spot oil prices have rebounded. Although this is clearly providing a trading opportunity, it may also be indicative of a bull trap for bottom-picking investors and I advise being cautious about taking a long-term position based on the immediate action.
I last addressed my concerns about the oil sector, especially the U.S. alternative exploration and development (E&P) companies, in the Nov. 12 column, "The Biggest Current Threat to the Markets."
Even with the big upside moves in all six of the individual company stocks referenced in that column over the past two days, they are still negative for the past five days and are down dramatically since that column was published.
Inclusive of the rally of the past few days, since Nov. 12, Continental Resources (CLR) is down 35%; EOG Resources (EOG) is down 15%; Hess (HES) is down 19%; Marathon Oil (MRO) is down 26%; Statoil ASA (STO) is down 8%; and the smallest among them, Whiting Petroleum (WLL), is down 37%. (EOG Resources is part of TheStreet's Action Alerts PLUS portfolio. Whiting Petroleum is part of the Stocks Under $10 portfolio.)
As bad as this performance is, and even though it represents a continuation of a slide that began for all of them in mid-2014 as spot oil prices began to decline, none has yet experienced a capitulation event, as far as I've been able to ascertain.
Also, as bad as this situation has been for all of the companies in the oil sector, the response by investors has been rational, orderly and logical in light of myriad negative forces being exerted on the sector, which I'll not rehash here.
What concerns me about this is that it still appears to be indicative of a general belief by the largest institutional equity holders that this, too, will pass, economic activity will increase, the supply-and-demand issues will dissipate, oil prices will rise and all will be well for these companies.
The reason for my concern in this regard is because of what has occurred to the deepwater ocean drillers over the past month, especially Seadrill Partners LLC (SDLP).
In the past month, Seadrill Partners stock has experienced a capitulation event, declining by 60%, on no news whatsoever. Everything that was known about the company's business, finances and prospects was known a month ago when the stock was already off by about 40% for the year. And then it just collapsed.
What's most disturbing about that action is the strength of the company's financial situation at the point of its collapse. It's got contracts through 2017, has positive earnings and even with its recent dividend cut is still rewarding income investors handsomely. The dividend cut was widely anticipated as probable all year, too.
For some reason, however, the institutional holders, the largest of which were Oppenheimer Funds and Goldman Sachs, with an 18% and 6% ownership of equity, respectively, as of Sept. 30, appear to have decided to sell those positions very quickly.
By comparison, the alternative E&Ps are all losing money, but so far a similar kind of decision has not been made by the institutions holding them.
There are two key issues in the immediate that cause me to be concerned about the prospects for oil prices to be able to maintain the upward strength of the past few days.
The first concerns oil demand and is that the Fed is wrong on the prospects for growth in the U.S. next year, and by managing monetary policy to a model vs. the real economy, it has increased the probability of exacerbating the negative economic trajectory.
Although I've written about this issue in numerous previous columns, including yesterday's, "When All Else Fails, Go to War," Larry Summers provided an excellent critique of the Fed on the same grounds yesterday.
The second concerns oil supply and is based on the fact that Saudi Arabia has announced plans to increase the rate at which it privatizes state-owned enterprises.
Although Saudi Arabia began the process of privatization in 2002, it has moved slowly. The new push to accelerate the process raises two disturbing issues. The first is that it will allow the state to absorb low oil prices for longer than the markets have been anticipating and perhaps even allow them to push them lower in the near term.
The second issue, which is more in line with my column yesterday concerning war, is who the buyers of Saudi state assets will be. It is logical that China will move aggressively to be a buyer and will by extension exert much greater influence on the country's oil sector than is now the case.
As pertains to the immediate issues for oil prices, if they reverse again from the very recent upward momentum, the prospects for a capitulation event across the alternative E&P space, similar to what occurred to Seadrill Partners, increases.
