Crude oil prices have been quite volatile lately, but still remain rangebound as they have bounced mostly between $50 and $60 a barrel since December.
There were many obvious reasons for the sharp decline in crude oil prices from a high of roughly $100 a barrel a year ago, the most basic of which being a supply glut amid slack demand. However, the current environment and outlook is much harder to pin down — thus the tug of war in crude oil prices.
Click to EnlargeOn one hand, the U.S. rig count has dropped like a rock to a 12-year low. Take a look at this chart for one major oil producer, Baker Hughes (BHI), as proof. Coupled with deep layoffs and cutbacks in the energy sector, that means future domestic production is going to be much lower for the foreseeable future.
Of course, demand is set to weaken further according to a recent OPEC report, and supplies continues to grow. So it doesn’t much matter in the short-term — or perhaps even the medium term — how much oil stocks like Exxon (XOM), Chevron (CVX) and the like are pumping the brakes on production.
It’s very difficult to predict a direction for crude oil prices amid all this chaos. But I am confident that there isn’t much upside in energy prices from here, and there might even be opportunity for further declines.
Global Factors Will Continue to Weigh on Oil Prices
The latest risk to crude oil prices is the tentative deal with Iran on sanctions. If economic roadblocks were lowered, Iran would assuredly increase its oil production and exports — further exacerbating an already bloated global supply picture.
Furthermore, turmoil in Greece is weighing on the euro and propping up the U.S. dollar. With economic problems in China and central bank easing of Japan on top of that, the greenback remains very much in favor — and a strong dollar acts as a headwind on crude oil prices.
Last but not least, there is the most recent forecast from the U.S. Energy Information Administration, which projects that “Brent crude oil prices will average $60/b in 2015 and $67/b in 2016,” with West Texas Intermediate crude oil prices about $5 less in both time frames. In other words, right about where we are now, with limited chance of upside for the next 6 to 18 months.
Thus, traders looking to play oil prices directly via an investment like the United States Oil Fund ETF (USO) may be able to make a profit by grabbing oil during a brief pullback and riding it up to a short-lived peak of $60 or even $70.
But if prices are going to average basically what they’ve averaged before, that doesn’t bode well for oil stocks that need a persistently strong crude environment to see improvement in earnings.
An argument can be made for diversification in energy for long-term investors, of course, or for the dividend power of certain oil and gas plays. But keep in mind that oil majors like Chevron and Exxon aren’t really trading for deep discounts despite 26% and 19% declines, respectively, in the last 12 months. CVX stock and XOM stock both have a forward P/E of about 15.5, which isn’t exactly a steal.
Thus, if you’re simply looking at oil stocks from a share appreciation perspective, you could be out of luck for the next year or so as the energy sectors continues to suffer.
There may be selective opportunities based on valuation or timing, but by and large I think investors should sit out oil stocks until crude oil prices recover … and that may not be until the second half of 2016, or even later.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.
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