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Either Oil Rebounds Above $80 Or Energy Stocks Fall By 40%

Several days ago we showed something remarkable: "current forward 12-month P/E ratio for the Energy sector is now well above the three most recent historical averages: 5-year (12.0), 10-year (11.9), and 15-year (13.6). In fact, this week marked the first time the forward 12-month P/E for the Energy sector has been equal to (or above) 22.4 since April 8, 2002. On that date, the closing price of the Energy sector was 225.15 and the forward 12-month EPS estimate was $10.05."


Further refining this analysis and using the S&P Energy Sector Index data, the sector's forward multiple is now an absolutely ridiculous, mindblowing 23x, the highest since 2002, having soared by nearly 100% in just the past few months as a result of collapsing energy sector earnings.


How is this possible?

Simple: as the chart below shows, since the oil's peak in June 2014, Energy company EPS have crashed by 50%, as a result of a 60% plunge in the price of oil. What about Energy Index prices? Well, they have fallen to be sure, but nowhere near far enough to where they should, down "only" 20% from the highs.

Related: Bearishness Continues Among Oil Industry Experts


So what does this mean? Simple: either the long-term PE multiple is now null and void, and the "New Normal" forward PE of 20X+ is realistic, which of course is ridiculous, or there are two alternatives:

• Energy sector earnings have to surge by 70%, implying a near doubling of oil prices to $88, for the forward P/E multiple to return to normal, or
• The Energy sector price has to crash from 549 today to 323, where it would trade down to its historic forward P/E multiple, suggesting a price drop of over 40%!

This is shown visually on the table below:


So which is it? Well, as the following chart showing a relationship we have grown to love over the past few months, the main reason why energy stocks are loathe to catch down to reality is the same BTFD mentality which is keeping the S&P elevated well over 100% above its fair "ex-central banker" value. Indeed, every single time even the smallest buying momentum arrives, energy stocks soar as if stung, only to recrash the day after precisely to where credit says they should be trading.

Related: How The Economy Is Tied To Energy


Which means that once the ongoing euphoria of a 5 year Pavlovian BTFD reaction wears off, the pain for those long energy equities (and credit, since the above analysis implies energy credits are also massively mispriced) will be unprecedented, unless of course, by some miracle, oil does indeed double from here and on very short notice.

But wait, it gets worse, because while equities are pricing in an unsustainable 23x in forward energy P/E, another market, that of interest rate forwards, is implying oil plunging down to $35! As a reminder, oil is among other things, a function of rate differentials or said simpler, USD strength, strength which appears is not going anywhere. And as the following calculation from Cornerstone implies, should the EURUSD tumble to parity which is what Draghi's desire seems to be, it would suggest a 22% plunge in oil from here, implying a $35.5 price of oil one year from now.


This in turn would mean that, all else equal, the forward PE multiple would rise to just shy of 30x, and/or that Energy prices as a group would have to tumble over 50% from current levels!

Of course, if and when energy prices are cut in half, this would also have devastating consequences on the rest of the S&P, and all other asset classes, and almost assuredly force the Fed to not only forget all about hiking rates, but promptly engage in QE4.


Which may be just what the market is pricing in.

The only problem is that one can't have a world in which both QE4 is priced in (as equities are doing), as well as pricing in the 2015 Fed rate hike (as oil is doing), and is one of the main drivers of the USD strength.

One has to give, and it has to give soon.

h/t Cornerstone

By Zerohedge

Source - http://www.zerohedge.com/ 

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  • Martin on February 03 2015 said:
    Having read through this article, one element did not make sense :

    As peak oil approaches/is reached, the logical question then becomes - should not the oil price then enter a phase similiar to an exponential curve ? Even as energy demand remains constant, diminishing resource makes the energy more expensive. This is the logical conclusion based on scientific principles.

    The mass flow rate of oil models the same process, so the same mathematical rule applies.

    Therefore, as neither of these events are happening, what then ?

    From the very most conservative estimates, the Oil Shales in North Dakota have a swept volume equal to the Gwahar Field in Saudi Arabia, the largest known. the equal, prior to drilling and extraction. The quality of oil in the shale strata is comparable. The Canadian oil sands are the same magnitude again.

    Europe has switched from petrol to diesel fuels for cars, and to hybrids, natural biogas, and so forth. High efficiency energy use systems also became the norm after the last 10 years of high oil prices. Car buyers have come to prefer high efficiency, low capacity engines - the 1.0L Ford Ecoboost is the high point of this development. The Tesla electric cars have also achieved breakthrough level of technology. People also need less travel by car, with some exceptions. Further, growth of electronics as means of social empowerment sees a lower energy lifestyle for the world as time goes by. We can go another step - Aero engines are at the peak of efficiency, and travel by air becomes less demanding as time goes by.

    Then, global warming has reduced energy consumption for heating except for areas that require it. There is a lowering of need for oil and coal, and a growing employment of power metals, renewable electrical energy, and before long we will have fusion power at last....

    So, in short, as the world moves away from oil for energy, and towards cleaner tech and cleaner employment of fossil fuels, the break point was 2014.

    A final issue is that those who use fossil fuels for transport are a diminishing percentage of the population. they have had fewer children, and those children are less interested in energy profligacy. That completes the loop.

    Europe is dying in terms of population, and is strangled by its own laws. As a result, energy use goes down, as the working population shrinks. Ditto Japan. Ditto, dare we say it, the rest of the first world. And even Mainland China - where the one child policy is being relaxed, perhaps too late....

    The next few years will be interesting indeed.
  • len on January 30 2015 said:
    You guys have had very insightful articles on fundamentals, but Do NOT start
    polluting this website with zerohedge dribble......the articles there as is this one
    slated towards constant bearishness and complete ciaos....24 hrs a day talk up gold
    while trying to crash the mkt..even though they have merits its a one way street and
    i for one dont trust them any longer. Further the articles on oil have been slated too and in some cases factless to make matters worse. To argue energy stks are over valued while the rest of s&p is at a high and the sector ex majors is down 50% makes my point. This dope doesnt say its the majors that havent fallen as much not the rest
    of the space....so there u go.

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