February 16th Weekly Market Update
No sector is getting more attention right now than energy. Market participants are attracted to the potential upside after both oil and the energy sector suffered substantial declines in recent months. Many see the sector as cheap, something that is not easy to find these days in the U.S. equity market. We drive by gas stations every day where we see prices have been cut in half, serving as a constant reminder of how cheap oil is. In this commentary, we discuss what we are watching to assess the opportunity in energy.
WHAT WE ARE WATCHING
Here are some of the key factors we are watching to assess the potential upside opportunity in the energy sector:
Supply. The massive drop in domestic oil price has been almost entirely supply driven, with modest contribution from slowing global growth. Thanks to booming U.S. oil production, inventories are not only well above the five-year range for this time of year, but they are near their highest levels on record. According to the International Energy Agency (IEA), the global oil market is currently about 800,000 barrels per day oversupplied (for perspective, the global oil market is roughly 94 million barrels per day). We do not expect a rapid supply response from producers given low marginal costs of continuing the most cost-efficient production, which means that lower prices may be required to balance the market. We would expect the bottom in oil to be put in once the market sees actual and meaningful supply reductions, which has not happened as of yet and could take several more months.
Future production plans. While plans for future production do not impact supply today, the oil market is forward looking and has been reacting to news that affects future production. Major oil producers such as BP, Chevron, and ConocoPhillips have cut capital spending plans by 10% to 15% in response to lower prices. Rig counts have fallen more than 30% from their recent peak. The drop in drilling permits has been similar throughout key oil-producing regions in the United States. But future capital spending plans do not help balance the oil market in the near term. So while we are watching these factors, the continued healthy pace of U.S. production even in the face of these cutbacks suggests the market may need lower prices, or more time, to balance.
For the full article: ENERGY SECTOR OUTLOOK: WHAT WE ARE WATCHING