Oil sector massacre surprised markets, not us

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… | Read More »

Oil Prices and Energy Stocks Hit the Skids. Now What?

In June of this year, front month oil prices were trading for approximately $107 and energy stocks were significantly outperforming the stock market for 2014.  Now oil prices are under $80 and most energy stocks have entered into a bear market (at least 20% correction).  What happened?  A combination of two events emerged to lay the foundation for the oil price plunge.  First, economic demand (and oil demand) coming out of Europe, South America and China has been quite disappointing.  Secondly, oil shale production in the United States has emerged as a significant contributor to oil supply growth.  Thus, with oil demand disappointing and oil supply growth strong it has led to an increase in oil inventories and a significant amount of excess oil looking for a home.  This has led to a substantial fall in oil prices and a corresponding decline in energy stocks. What happens next?  While this is a difficult question to answer, our reading of the tea leaves sees a showdown between OPEC and the United States.  Historically, when oil supply and demand would get out of balance OPEC would adjust supply to match demand and avoid sudden oil price declines.  It appears OPEC is now playing a market share game.  OPEC sees the abundance of oil production growth in the United States and it does not like to see one of its top customers now become a competitor.  If OPEC had just adjusted supply downward to make room for the shale oil production in the U.S. they would have had to concede market share.  Furthermore, the elevated prices also would have motivated the United States to further grow their shale oil reserves.  Thus, OPEC elected to allow oil prices to fall with the hope that it will slow down U.S. shale oil production.  Most oil experts estimate that U.S. shale oil production comes at a higher marginal cost than the typical OPEC barrel of oil. … | Read More »