Oil stocks are finding some strength this week, even as oil prices remain lagged under $50 a barrel. I see investors again trying to pick a bottom on oil stocks. I say that these efforts are, for now, doomed to fail, as the full brunt of the shale bust is yet to be felt.
I understand the hopes of many investors who have poured money into oil stocks this week, despite an oil price that remains very depressed. I could make the case myself – first, oil stocks have been vast underperfomers of the S+P 500 and are certainly due to have their day. Production numbers for the week are slightly down for the first time in many months, perhaps indicating that the slashing of rig counts we've seen is finally translating into the drops in production necessary to end the crude price slump. Finally, the dustups in the Middle East, from the Saudi military activity in Yemen to the ever more troubling extensions of the Iranian negotiations all seem to point to a moment to shift back into oil. But I say not yet.
It is not that I think that oil is going to again breach the low $40s in price. There is a market theory of a crude 'clearing price', where oil finds buyers and less traditional routes to move out of glutted areas no matter what the fundamentals of supply and storage might say. I think that is right and the idea of low $30s targets on oil, or low $20s as Citibank has called for to be downright ridiculous. But it is the thought that oil can again rally into the profit zone above $60 that I find equally ridiculous now.
Production does matter, and we are at the limits of traditional storage. Further, if the E+Ps haven't collectively lied in their recently quarterly presentations, production is definitely going up this year. Finally, there are literally dozens of oil companies who could buy themselves another year or two of life should they be able to sell financial futures anywhere near $65 a barrel. That means a wall of real commercial selling should oil rally. I don't think it will.
Stuck in this $45-$55 area for the next several months, we'll still need to see a lot more consolidation, defaults and outright bankruptcies, in my opinion – most of the oil stocks I am modeling are pricing today based on $75 oil, including even the best financed ones I love, like EOG Resources (EOG), Cimarex (XEC) and Anadarko (APC). I will admit to having a core position in two of these, having recommended EOG under $90 and Cimarex as it was trading closer to $100. But I cannot add to them at levels that price in a crude barrel I don't think we can see until at least the 2nd quarter of 2016.
In a stock market that is calling for a sector shift, as I think this one is, there is the natural tendency to reach for the underperforming sector – oil. I cannot deny this instinct and instead have tried to circle back to the big integrated names for starting fresh positions these last few weeks, particularly concentrating on those with solid downstream storage and refining assets and, if possible with non-US names to take advantage of a dollar arbitrage I think is coming. Interesting to me are Royal Dutch Shell (RDS.A), Canadian oil behemoth Suncor (SU) and French giant Total (TOT).
I understand that fear of missing the next great oil boom that many investors believe (correctly, in my view) is coming. But now is not the time and these are not the levels to bet on high beta oil names. It's still wiser to wait it out in larger cap integrateds until more blood in US shale players is spilled. And with oil staying in this range for several more months and perhaps quarters to come, that blood is still to come.