Surging Oil Prices and Analysis of Oil Stocks

Oil Prices and Oil Stocks have been a topic of intense discussion and analysis in recent times. The volatility in the energy sector and the invasion of Ukraine have had a significant impact on oil prices. Analysts have been closely monitoring the trends in the oil and gas industry, especially the rise in crude oil prices (see recent New York Times Article -27 September 2023). In this article, we will delve into the intricacies of the oil industry, explore the potential of oil stocks, and analyze if this is a good time to buy oil stocks.

One of the key factors influencing the performance of oil stocks is the price of crude oil.  However, this depends on the business cycle, suppy and demand conditions, plus the impact oil prices could have on inflation and what this means for monetary policy and interest rates.

Higher oil prices not only benefit oil companies but also impact various aspects of the market. The price of gasoline at the pump is directly influenced by the cost of crude oil. As crude oil prices rise, consumers have to bear the brunt of higher energy prices. This, in turn, can impact consumer spending habits and have broader implications for the overall economy.

Oil Stock Valuations

Ironically, the biggest risk to oil stock valuations at this point in the business cycle is the affect or oil prices on inflation.  If oil prices stay higher for longer, then these increasing costs will impact core inflation. This will then push down energy market valuations due to a bigger slowdown in the economy versus expectations.

Thus, our view is that oil stock valuations are more uncertain than is commonly perceived in the market.  Taking into account restricted supply from Saudi Arabia (see New York Times Article – 04 June 2023), Russia’s invasion of Ukraine, tight oil supply conditions in general, and the recent drawdowns in inventories would suggest that crude oil will surge a lot higher.

I would express caution at this narrative.

Yes, it is true that the oil market in now in backwardization, meaning that shorter date oil future contracts are higher priced than longer term oil future contracts.  In short, this is a condition of tight markets and is a way of saying the futures market won’t pay for storage of oil thus it should be brought to market now since prices are higher today than tomorrow.  Notice that US crude inventories are falling, and the Energy Information Adminsitration (EIA) noted a inventory drawdown of 2.2 million barrels recently.  Additionally, the level of oil stocks at the Cushing oil hub are at their lowest since July 2022.

While the headline crude oil benchmarks like West Texas Intermediate (WTI) and Brent are up, this will provide incentives for countries to cheat and produce more and also increase pressure on Saudi Arabia that if prices go too high then the risk of a price crash is higher.

Thus, we remain negative on oil stocks at this time in the global business cycle.   Short-term, we expect a modestly bullish uptick in oil stocks like BP, Exxon, Chevron, Phillps 66, Devon Energy and others.  However, energy investors and especially short to medium term traders should remain cautious.

Additonally, we are negative to very negative on a Chinese recovery, see a weakening European market, US Shutdown, US Student Loan Repayments, and impact of tight policies on the US economy that do not bode well for rising oil prices in the medium term.