Oil sector massacre surprised markets, not us

John Hintz, CFA®
John Hintz, CFA®

On Nov. 12, 2014, we posted a blog noting that WTI oil prices had fallen from over $100 per barrel in June to just under $80 per barrel.  In it, we discussed a scenario in which oil prices would probably have to fall below $70 as our reading of the tea leaves was that OPEC was not coming to the world oil market’s rescue like it had almost universally in the past. Our thought process as laid out in the blog post was that OPEC (mainly Saudi Arabia) was more worried about maintaining market share than it was seeing oil prices head lower.  The emergence of non-OPEC oil production, especially U.S. oil shale, was just expanding too rapidly for the liking of the Cartel.

Sure enough, on Thanksgiving Day, OPEC held a meeting to discuss cutting production.  To the market’s surprise (but, not Winch Financial’s), OPEC did not lower their production quotas and discussed how non-OPEC production and especially U.S. shale oil was growing too rapidly.  OPEC decided they would let the market price be set by true supply and demand and were not going to give non-OPEC oil producers a free ride.

The oil and energy stock markets were massacred on Black Friday once the market digested what a bold move OPEC had just made while we were busy eating our turkey.  Oil prices fell by over 10% to $66.10 and many energy stocks were down over 20% in one trading day.

Contrary to market consensus, OPEC did exactly what Winch Financial called for and the energy stocks paid the price like we expected.

What now?  With oil prices in the mid $60s down from $100 as recently as July and many energy stocks having been cut in half, it appears the consensus is currently to buy the dip in oil prices and energy stock prices.  We are not as confident as the market.  We do not see the recovery in oil prices and energy stocks as being a V-bottom and instead envision more of a U-bottom.  We expect oil prices to trade in a range of $60 to $70 as the oil market tries to find the clearing price that will get non-OPEC production to slow down to take out the excess production in the market.

While energy stocks might look enticing, we think it will be hard for energy stocks to outperform the stock market until oil prices firmly mark a bottom and start increasing once again.  This is a process that is likely to take months and not days. We clearly expect some sharp upward moves on days where bottom fishers try to call a bottom in energy prices and energy stocks.

However, our advice is that while we are now closer to a bottom than we were at the time we posted our first oil-related blog, it is still necessary to exhibit patience in buying energy related stocks.