As Brent oil touched $50 a barrel today for the first time since November of 2015, we've banked a lot of profit in our core Exploration and Production portfolio. But as well as we've done, there is historical data to believe we should be doing better.
Nick Colas, the analyst for Convergex, wrote an interesting piece examining the relationship between oil prices and oil stocks, a solid connection I've always relied upon. In essence, Mr. Colas has noticed a relative correlation between oil prices and stocks of around half – In other words, if oil prices go up or down a percent, the oil stocks in general will move a half of a percent.
All this becomes interesting if we mark the movement of oil since hitting its lows in February. Since that time, oil has rebounded 89 percent, while oil stocks – as marked by the S&P Select Energy Index (IXE) – is up 29 percent. This may be less indicative of anything, as stock markets obviously have other inputs working into them than commodity markets, particularly in an active Fed and election year. The numbers get less extreme by using data for 2016 alone; oil is up 33 percent year to date while oil stocks are only up 12 percent.
All of this might point to the fact that we should still be buying oil stocks, as an 'additional' 5 percent of gains are already built into oil's price. But it also speaks to the fears that investors still retain on oil stocks, specifically their collective ability to survive, their fears that higher prices will again spur overproduction and oil's ability to sustain its price gains, if not advance further.
And here, I have something to say. First, we've been very diligent in our choices of energy stocks, and we've engaged a strategy that an energy index cannot match – particularly knowing that all oil companies are not created equally. In this environment, we have proven that some will make it, some won't and some will particularly excel in the next boom cycle to come. Second, we've delivered predictive negative arguments on the ability of U.S. independents and even state-controlled oil companies outside of OPEC to ramp up production in the face of $60, $70 or even $80 oil. The environment for fresh capital and particularly fresh debt in the oil space makes a quick return to free capital spending and production impossible.
And finally, about oil's price trajectory from here: This is less easy to say. In my mind, the new trend is in – no matter where oil prices go, there is now a more short term bias to prices drifting lower, where opportunities to buy oil stocks will emerge, to a long-term bias lasting for the next 3 years for prices to move significantly higher. No one who has even read one or two of my columns is unaware of my $120 oil call by the end of 2017 – a stark contrast to Citibank's analysis, just now raised again to a measly $61 in the same period. We'll easily surpass that by the end of this year, as the rest of Wall Street continues to play catch up to the new oil boom that's approaching.
But for us, there still remains a bias against energy shares. According to Convergex, it's at least 5 percent.
And that's good, because according to my belief of the continued strength in the sector, you still can buy select oil stocks at a discount.