A disparity between company valuations and the oil price is becoming apparent, and data from both the International Energy Agency (IEA) and US Energy Information Administration (EIA) is increasingly looking bullish. The price action of oil is narrowing towards a tighter zone, edging closer to deciding its next trend. If it’s a positive move up, could we finally see a significant rise in oil stocks?
The IEA and EIA both provide crucial analysis of the oil market. Arguably the EIA gains more attention with its inventory reports visibly impacting price movements most weeks. Recent figures have shown modest builds in inventory and last week, we witnessed strong draws of product inventories counteracting a build in US crude storage.
The price of WTI Crude Oil has been consolidating above $60 after dropping back off January’s highs of $66. Crude’s price action is closing-in ever tighter to a pivotal point and is sandwiched between its 50 DMA and 100 DMA.
A decision will be made soon, and so far on this occasion, Brent has lead the way, already breaking out of its triangular price action predicament. The good news for oil bulls is that it culminated a breakout upwards, although it too is struggling to put its 50 DMA behind it.
The timing of this quandary for the oil price is aptly in sync with the global markets generally, with most world indices still undecided on their future trend. That perhaps makes investing in oil stocks either doubly exciting or terrifying depending on your risk tolerance!
Lagging share prices
One thing’s for sure, oil stocks haven’t fully reacted to a strengthening oil price, and I sense caution with all the balls still in the air so to speak. Take a look at a selection of oil stocks and compare their valuations to the oil price.
Generally, gains in stocks appear to have been withheld. I’m not surprised with the current global uncertainty – Global markets may prove to have topped, and there will likely be a colossal equity sell-off if proven so. Recent headlines talked of USA oil production undergoing dramatic growth, counteracting some of the reductions OPEC (and some non-OPEC) countries have strived for by capping their capacity.
Debt to survive
In many cases though, the issue will be lingering debt. With oil companies used to receiving $100 per barrel, many got caught out when the oil price plummeted. Years of substantial investment during the good times caused the glut, and many companies had already signed off on further costly expansion before the collapse of the oil price in 2014. There were a number of causalities, with others clinging on for dear life – cutting costs and rearranging debt to adapt to a low oil price environment.
The glut does appear to be dissipating now though, and the EIA reports that US storage is now in line with the 5-year average. In fact, if this year’s lack of large inventory builds is anything to go by, we could see US storage going below the 5-year average by the time the summer driving season is underway. As you can see from the chart below, the yearly oil balance cycle typically begins with inventory builds until the end of April, where after declines are commonplace.
The latest IEA Oil Monthly report (OMR) for March concurs with the EIA figures. Compare 2018’s outlook now with that forecast six months ago in October, and you’ll see the IEA has downgraded its Demand/Supply differential. The agency is now predicting demand outstripping supply for the last three quarters of the year.
Is it any wonder? With company purse strings still tight, it’s clear the sector is likely to face a lack-of-investment snapback. Oil firms are continually fighting to replace reductions in output caused by the natural declines of wells. Industry-wide these declines equate to the entire production of the North Sea each year.
Perhaps reports of record levels of US production have been a bit of a Red Herring. The US has cut its net crude imports by 50% since 2003, but that’s a distraction against increasing China imports and those of India. Let us not forget, India has only just got the motor running with a vast potential for further consumption over the coming decades. It could well be that renewables bite the ass of oil a lot sooner than the industry dare acknowledge, but at least for now, the insatiable demand for oil continues.
In recent news this week, Saudi Arabia doesn’t seem in too much of a hurry to float Aramco. There will be a further delay of its IPO, which is now likely to be scheduled for 2019. As Bloomberg Gadfly speculates, they may need oil at $80 a barrel to justify Aramco’s $2 Trillion valuation. Are they confident (along with Goldman Sachs) that oil is heading higher, or just hopeful?
Well, they’re not alone, far from it. A look at the Commitment of Traders (CoT) standings shows bullishness on Crude at near all-time highs with record longs and diminished shorts recently hit. This can either be seen as a positive indicator – reassuring bulls, or one to view with caution since markets don’t tend to stay at their extremes for long.
If oil bulls are right, we could be on the cusp of seeing another move north. A steady climb would be more beneficial to the industry than a spike, which could result in a strong sell-off by speculators taking profits. Either way, oil companies could be poised to move, and those with valuations strangled by debt could be about to be set free on the road to recovery.
Author: Stuart Langelaan