By Michael Brush, MarketWatch
Investors, it’s time to bulk up on oil and energy stocks. Oil has reached the bottom in its current selloff, and it will move up from current levels.
Here are seven reasons why, followed by 20 of the best ways to play the coming rebound in oil.
1. Saudi Arabia needs the cash
Saudi Arabia uses its prodigious oil revenue to support vast government giveaways and jobs programs, to keep its citizens happy. It needs oil at $88 a barrel to support these generous offerings and balance its budget. With Brent oil in the low $60 range, the shortfall is big. So Saudi Arabia’s days of driving down oil as a favor to President Donald Trump may be numbered. It’s the same elsewhere inside the Organization of the Petroleum Exporting Countries (OPEC). The United Arab Emirates needs $71 oil to balance its budget, according to the International Monetary Fund.
“If you don’t keep paying the masses, they might revolt on you,” says energy-sector expert Mike Breard at Hodges Capital Management. This is one big reason why when OPEC meets Dec. 6 and 7, it is likely to agree on a production cut of one million barrels per day (BPD) or more.
A similar dynamic puts downward pressure on U.S production. U.S. shale producers need West Texas Intermediate (WTI) prices of $55 a barrel on average to cover costs. They don’t collude as a cartel, as OPEC does. But market forces undermine production growth when prices fall below $55. WTI recently traded at around $51 a barrel. (Note: See chart in this story indicating break-even oil prices by country.)
2. Sentiment got too dark
With oil and many oil-related stocks now in a bear market, this is understandable. The pain has been intense. Recently, much of the media has piled on to the negative view, which is often a bullish sign for an asset class in the contrarian sense.
Jim Cramer, for example, recently predicted oil would fall to $40 a barrel. Cramer is as good a heard-following contrarian indicator as any. So I take his dark bearishness on oil as a good sign that oil is at or near a bottom. Thank you, Jim, for the signal.
3. Insiders are bullish
I watch insider activity on a daily basis, for the sector and stock analysis at my stock newsletter, Brush Up on Stocks . Over the past few weeks as oil prices and energy stocks have plunged, insider buying at energy companies has stepped up meaningfully. It’s typically a great buy signal when investors and the media have turned dark and insiders turn bullish. This is the trifecta I regularly look for to make bullish contrarian calls on a sector or the market.
4. Spare oil capacity is tight
At somewhere between 1.5 million and two million BPD in potential production, spare capacity in the global energy production system is just about the lowest it’s been in the past decade, points out Justin Thomson, who manages the T. Rowe Price International Discovery Fund /zigman2/quotes/206936003/realtime PRIDX -0.64% .
That’s a problem for energy bears because “outages are a fact of life and they tend to average at 2 1/2 billion barrels of oil equivalent a day,” says Thomson. “It would only require smallish outages for oil to spike again.” Thomson is worth listening to because his fund beats the funds in its category by 2.3 percentage points a year annualized over the past five years, according to Morningstar.
What might cause production outages? Look no further than the “Fragile Five,” or Venezuela, Libya, Nigeria, Iraq and Iran, where domestic instability can quickly take production offline. They account for 12% of global oil production. So the risk to production from problems in the Fragile Five is substantial.