So far, 2015 isn’t shaping up to be a good one for energy investors. The last few months have been a continuation of the bloodbath started late last year, when OPEC decided to keep pumping to maintain its market share.
Lower energy prices across a multitude of commodities and sectors continue to plague the sector. Global demand just isn’t what it used to be, courtesy of energy efficiency gains and lower economic output. Meanwhile, supplies of various energy resources — from crude oil to coal — remain at elevated levels.
Needless to say, when your profits are driven by those underlying energy prices, your share price is going to suffer.
And suffer they have. The broad Vanguard Energy ETF (VDE) is down about 22% year-to-date.
With the critical fourth quarter about start, energy investors may want to brace themselves for another quarter of disappointments and perhaps raise a little cash to take advantage of any long-term deals that come our way.
Energy Prices To Stay Low For Longer
To say that crude oil has been quite volatile would be an understatement. Prices for Texas Tea recently hit a new 6-1/2 year low of $37.75 per barrel. However, for most of the last few months oil has bounced around between $40 and $60 per barrel on every piece of good or bad news.
Unfortunately, the bad news keeps coming.
Let’s start with the situation in China. Beijing’s recent decision to devalue its currency has whipped up panic about softening economic growth in the world’s second-largest energy consumer. Lower PMI/manufacturing numbers for the emerging market powerhouse and mega-mainland stock market declines have also fueled the fire.
If China is slowing down, we’ll see the effects across the entire commodities complex and not just in energy prices. As the world’s key demand driver, any dip in GDP activity during the fourth quarter seriously drop its demand for crude oil.
Worse, all of this China news comes at a time when the world awash in oil.
Supplies of West Texas Intermediate (WTI) crude oil in the U.S. remain near 80-year highs. All in all, the United States has a commercial crude inventory of just over 454 million barrels. Part of the problem is that improved drilling efficiencies and technologies have continued to push up supplies even though the number of drilling rigs in operation continues to decline each week.
In other words, producers are drilling less, but getting more per well.
On the flipside, the OPEC nations of Saudi Arabia and United Arab Emirates continue to pump more crude oil. The latest data showed that OPEC’s production rose by 13,000 barrels per day throughout August.
Neither of these things are great for energy prices.
In fact, the Energy Information Administration (EIA) estimates that we’ll see $47 per barrel prices for WTI crude oil and about $52 per barrel for Brent benchmarked crude oil by 2016. That’s basically a continuation of today’s sideways market for energy prices.
And it’s not just crude oil that’s suffering; natural gas is also feeling the pain.
Natural Gas Stocks Are Also Sinking
While firms like Cheniere Energy (LNG) and Dominion (D) have made progress on their LNG export facilities and new ethane crackers continue to be in the planning/construction stages, they haven’t really begun to “cook” and remove much of the excess supply of natural gas. Adding insult to injury, the summer was relatively mild, which reduced utility demand for the fuel source.
Again, a high level of supply and low demand has sent wholesale energy prices for natural gas down to the sub-$3 mark.
For stocks that rely on higher energy prices — like Exxon Mobil (XOM) or Chesapeake Energy (CHK) — this is bad news indeed. Moody’s shows just how bad it could be: The ratings agency estimates that the energy sector will be cash flow negative to the tune of $80 billion this year as lower energy prices persist.
That figure is about a $54 billion in less cash flows than last year. That kind of drop will cause companies to cut capex spending on new projects in spades as that $50 per barrel mark is critical to keep many projects in the black.
The only possible bright spot in the entire oil & gas sector for the upcoming quarter is the downstream players. Refiners — such as Valero (VLO) and Western Refining (WNR) — have been able to feast on lower energy prices and boost their already fat margins.
With oil and natural gas expected to be range-bound throughout the fourth quarter with no real catalyst pushing energy prices upwards, refiners should continue to rack up these gains.
Playing The Same-Old Same-Old
At the end of the day, oil and natural gas are still hurting and they’ll continue to hurt during the fourth quarter. The new “lower for longer” mantra is certainly holding true, and unless we get some real growth coming from China, Europe or here at home, we should expect the world to continue to be awash in crude oil and natural gas. It’ll probably be well into 2016 before we see any real price gains.
The best course of action for the next three months is to raise cash to take advantage of any of the deals on quality energy stocks with long operating histories, good assets and strong margins. Alternately investors can use any weakness to load up on index ETFs — like the previously mentioned VDE or iShares US Energy (IYE).
Likewise, buying shares of crude oil end-users — the refiners and other downstream players — makes a lot of sense going into the end of the year.
Just keep in mind, things could get worse before they get better with regards to energy prices and the stocks within the industry.
As of this writing, Aaron Levitt was long VDE and VLO.