~$70 a barrel crude (ii)

Two factors are moving the Energy sector higher.  The obvious one is the higher oil price during a normally seasonally weak time.  In addition, though, the market is actively looking for alternatives to IT.  It isn’t that the bright long-term future for this sector has dimmed.  It’s that near-term valuations for IT have risen to the point that Wall Street wants to see more concrete evidence of high growth–in the form of superior future earnings reports–before it’s willing to bid the stocks significantly higher.  With IT shunted to the sidelines for now, the market is not being a picky as it might be otherwise about alternatives such as Energy and Consumer discretionary.

The fancy term for what’s going on now is “counter-trend rally.”  It can go on for months.

 

As to the oils,

–a higher crude oil price is clearly a positive for the exploration and proudction companies that produce the stuff.  In particular, all but the least adept shale oil drillers must now be making money.  This is where investment activity will be centered, I think.

 

–refiners and marketers, who have benefitted from lower costs are now facing higher prices.  So they’re net losers.  Long/short investors will be reversing their positions to now be short refiners and long e&p.

 

–the biggest multinational integrateds are a puzzle.  On the one hand, they traditionally make most of their money from finding and producing crude.  On the other, they’ve spent very heavily over the past decade on mega-projects that depend for their viability on $100+ oil.  This has been a horrible mistake.  Shale oil output will likely keep crude well short of $100 for a very long time.

Yes, the big multinationals have all taken significant writeoffs on these ill-starred projects.  But, in theory at least, writeoffs aren’t supposed to create future profits.  They can only eliminate capital costs that there’s no chance of recovering.  As these projects come online, they’ll likely produce strong positive cash flow (recovery of upfront costs already on the balance sheet) but little profit.

The question in my mind is how the market will value this cash flow.  As I see it–value investors might argue otherwise–most stock market participants buy earnings, not cash generation.  Small companies in this situation would likely be acquired by larger rivals.  But the firms I’m talking about–ExxonMobil, Shell, BP…–are probably too big for that.  Will they turn themselves into quasi-bonds by paying out most of this cash in dividends?  I have no idea.

Two thoughts:

—–why fool around with the multinationals when the shale oil companies are clear winners?

—–as/when the integrateds start to show relative strength, we have to begin to consider that the party may be over.  So watch them.

the wobbly crude oil price

Over the past week or so, the world crude oil price has dropped by about 10%–although it is rebounding a bit as I’m writing on Wednesday morning.

I have several thoughts:

–this is the weakest part of the year for crude oil demand, since the winter heating season is over and the spring driving season is yet to begin

–the surprising aspect of recent crude oil prices is not that they are weak, but rather how strong they have been in January and February in the face of a rising rig count in the US and a milder than average winter in heavily populated areas around the world

–hard as this may be to believe, the price drop suggests to me that many traders in the crude oil market are new to the game, and for some reason haven’t filled themselves in beforehand on the basic characteristics of the commodity

–since there’s a direct relationship between the price of oil and the price of oil exploration and development stocks, the current odd price action in the crude market makes evaluating and trading in the equities more difficult

–I’ve built a small position in e&p stocks over the past couple of months, so I’m sitting on my hands.  If I owned nothing, I’d be tempted to buy something–although I’d be more comfortable if crude had been gradually declining in price over the past month, rather than exhibiting the panicky behavior of the past week.  This is also predicated on the idea that what’s driving crude is thoughts #2 & #3.