October 19, 2005
Is the bull market in oil history?
More than a few investors have suffered from believing in no less at various points in the last few years. When a barrel of oil changed hands at $30, many said it would never reach $40. When it did, $50 a barrel was thought to be impossible. When $50 was crossed, the shock and awe was even more potent, as it was when crude passed through $60, and when it recently touched $70. The sight of dowdy oil-company shares climbing right along with crude's price was equally surprising for many investors.
Now that the bull market in energy is accepted wisdom, is it time to throw it out, if only for a time? It's a bit easier to argue in today that the head of steam that oil prices have maintained in recent years has evaporated. Crude, as we write in mid-afternoon New York time, is down by more than $1 a barrel to around $62. That's well below the $70.85 intra-day peak reached in September. Perhaps more importantly, the low-$60 reached of late has come without much fanfare, and in a slow but persistent downward spiral, suggesting that speculators are unwinding positions.
To be sure, there's news weighing on crude's price these days, starting with forecasts that Hurricane Wilma approaching the U.S. is now expected to avoid delivering any major damage to energy infrastructure in the Gulf of Mexico. Adding to the selling mood is news today from the Energy Department that crude inventories in the U.S. rose more than expected last week. The 5.6 million-barrel advance for the week through October 14 moved the total up to 312.0 million barrels, which represents "the upper end of the average range for this time of year," the government explained. In addition, OPEC announced that its current production capacity would jump by around 17% in five years, Bloomberg News reports.
With the major oil companies set to report third-quarter earnings next week, speculation about where energy equities go from here, having already left most other sectors in the performance dust this year. The energy sector in the S&P 500, for instance, posted a 27% rise in 2005 through yesterday, according to Standard & Poor's data. None of the other nine sectors that comprise the S&P 500 even came close. In fact, the second-best sector so far this year (utilities) posted a respectable but still distant 9.8% year-to-date rise. Next is health care, up 1.7%. The remaining seven sectors all suffered losses so far in 2005.
Energy stocks clearly look good in the proverbial rear-view mirror, but can they keep the party going on a relative and/or absolute basis? BCA Research asked as much the other day when the shop opined: "The sharp rise in long-term earnings expectations for global oil & gas stocks makes them more vulnerable to a pullback in energy prices."
Now comes yet another research report raising questions, this time from Neil McMahon, Sanford Bernstein & Co.'s oil man in London, who warned in a report today that next week's earnings reports from Big Oil will "disappoint." With a forecast that's 10% below the consensus outlook for biggest oil firms, McMahon is effectively sounding the alarm. It's "our belief that one outcome of the quarterly reporting season is likely to be weakness in upstream realizations due to lost production from high margins areas, significantly lower marketing margins, weaker chemicals earnings and increased costs all of which indicate negative earnings surprise," he wrote to clients today.
What's that you say? Energy stocks will stumble with earnings relative to what the crowd expects? Say it ain't so. Alas, McMahon, who's gotten more than a few things right in the 21st century in forecasting the oil sector, gives aid and support to those looking for an excuse to cash in their oil-equity winnings.
Yes, the long-term geological forces are still in play, which is to say that finding oil isn't getting any easier. That's unlikely to change any time soon, if ever. But don't expect that backdrop to automatically translate into easy and continuous earnings gains each and every quarter for every oil company, he implied.
McMahon also suggested that in the long run, the ascending challenge of finding big new oil fields might actually work against some oil companies, particularly those that aren't able to replace reserves. Essentially, the cost of searching is going up in a world where the low-hanging fruit has been picked. Accordingly, there's a declining payoff from all the increased spending on searching. As McMahon observed, "With increased capital expenditure being directed towards exploration, the integrated oil group has yet to come up trumps, and the scramble for LNG [liquefied natural gas] positioning and oil sands acreage/companies by the group begs the question…are they really covering up for poor exploration success?"
The first of many clues arrives next week in the form of earnings reports. To judge by Wall Street, however, optimism still burns bright. "Eight of the 14 top-ranked industry groups [based on earnings expectations] for this week are oil-related," according to a report published Monday by Zacks. "Within those eight industry groups, there has been 307 full-year earnings estimates revised upwards versus 102 revised downwards – a ratio of 3-1."
In fact, Exxon Mobil Corp., Chevron Corp., BP, ConocoPhillips Co. and Royal Dutch Shell are expected to report a $9 billion, or 43 percent, rise in their combined third-quarter profits, according to analysts' estimates compiled by Thomson Financial, reports AP via Star-Telegram.com. "They are just printing money right now," oil analyst Fadel Gheit at Oppenheimer & Co. in New York tells AP. "They are making so many trips to the bank because they can't take all the money there at one time."
A correction in oil stocks may be coming, but for the moment the crowd doesn't see it. Of course, the crowd didn't see the bull market in energy either.
Posted by jp at October 19, 2005 6:25 PM
...came upon post by Stu this A.M. and want to give a thumbs-up to the McDep web-site. Free info is posted after subscribers recieve it, but still proves extremely valuable to me...
Posted by: lotek at November 4, 2005 10:51 AM
Great blog site, good writing.
O/G firms are awash in cash this year. Operating Cash Flow is the measure to watch. Take your eyes off the large integrated firms, and focus on some of the mid-tier guys who have aggressively invested and are now producing record volumes. A great starting point is www.mcdep.com. Kurt Wolfe should be linked on your site. See his recent recommendations like Encana, BR, Cimarex. What to do with all that OCF?
Who is buying back stock and who is continuing to wildcat?
Posted by: Stu at November 2, 2005 1:56 PM
...oil HAS HAD a correction (if you're long you know it). I've made some terrific plays, and I still own some long-term picks; but my sentiment is that energy (especially domestic natural gas (until LNG imports come on BIG)) will re-write the "conventional wisdom" book on the Boom / Bust cycle in this sector going forward...
Posted by: lotek at October 19, 2005 9:34 PM