Canadian energy stocks prices to perfection
For the most part, energy stocks follow the price of the underlying commodity. As crude oil prices fall, energy stocks fall in tandem, although not always by the same magnitude.
Crude oil prices and energy stocks both peaked in the summer of last year, when West Texas Intermediate (WTI) hit a high of $107 per barrel. As oil prices began to fall, energy stocks also began declining at a similar pace. In mid-December, crude oil prices broke $60, but stocks began to rally in anticipation that oil prices would reverse. Even though WTI slid to a new of $45 in late January, energy stocks shrugged off the decline and continued to slowly chug higher. In fact, at Friday's close, energy stocks have rebounded back to the $75 oil level, even though crude oil is trading closer to $50 per barrel.
So why the big divergence? Two reasons:
- Energy stocks (and all stocks in general) are forward looking. In other words, it's not about where oil is trading today - it's about where oil prices are heading tomorrow. Therefore, energy investors are clearly expecting prices to rebound back to the 75$ range in the short term.
- For most of us, the memory of 2009 is quite fresh. Although oil prices fell sharply from $140 to $35 in 6 months, they jumped back to $75 just as quickly, and most energy stocks went on to hit new highs. While in 2009, stocks and commodities bottomed at the same time, clearly this time traders are hoping to get a jump on the competition and are piling into energy stocks a few months ahead of schedule.
So is 2015 just a repeat of 2009? Consider the differences:
- The market crash was precipitated by a collapse of the US housing market which caused a crisis in financial markets.
- US oil production was 5 million barrels per day. The crude oil supply/demand curve was in balance.
- US Federal Reserve interest rates were 1.5 to 2.0% and pushed lower after the financial crisis. This helped keep the US dollar low which is good for commodity prices.
- Weak global demand caused a collapse of the crude oil market and all commodities in general.
- US oil production is 9 million barrels/day. Crude oil markets are oversupplied by an average of 2 million barrels/day.
- US Federal Reserve rates are at 0.25% and can only go up from here. Rising interest rates would strengthen the US dollar which is bearish for commodities, including crude oil.
In short, the current weakness in oil prices are caused by weak global demand, too much oil supply and a strengthening US dollar. So what's the probability of oil rebounding to $75 by the summer.
Ironically, the oil markets are currently in a chicken-and-egg scenario with supply numbers. News of rigs coming offline sends oil prices higher on hopes of lower production. However, energy service giants like Halliburton and Baker Hughes stand ready to redeploy those rigs should prices get back to the $60 breakeven level. That would be bearish for oil markets. Therefore, oversupply issues are not likely to be fixed in a 6 month period. Oil production will only seriously decrease if oil prices remain below the cost of production for several years. The only fix for the current slump in crude oil is very strong economic growth in emerging markets, strong enough to suck up the extra supply. Something not likely to happen any time soon.