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 (NAS:PRIDX) .
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.
5. Global demand is stronger than people think
“We are not seeing signs of demand weakness. Demand has been surpassing to the upside for three or four years,” says Jonathan Waghorn, a portfolio manager at Guinness Atkinson Global Energy Fund (NAS:GAGEX) , which beats competing funds in its category by three percentage points a year, annualized, over the past five years, according to Morningstar.
This may seem surprising given the signs of a global economic slowdown, and all the reasons to be concerned about global economic growth. They include: Signs of a slowdown in Europe and China, and possible disruptions caused by the breakup of the European Union over Italian debt issues and Brexit.
Two of the biggest concerns appear to be on their way out, though, or aggressive Federal Reserve interest-rate increases and U.S.-China trade wars. We’ve seen declining risks on both fronts in the past week, as I recently suggested might occur.
Progress on U.S.-China trade are a big deal for oil demand because China accounted for 40% of global energy demand growth last year.
6. Iranian oil import waivers won’t last forever
The Trump administration is re-imposing trade sanctions on Iran, but it issued temporary waivers on oil to several big importers of Iranian crude. Those waivers will roll off in March or April. Unless Trump changes course again, that’ll mean Iranian production will drop by 2.4 million barrels per day, to 1 million BPD from 3.4 million now, says Waghorn. For context, global daily oil production is around 92.5 million BPD.
In the background, the U.S. Treasury Department is in the process of knocking Iranian banks off the SWIFT global payments processing system, which will make it harder for countries to import Iranian crude, points out Larry McDonald of The Bear Traps Report.
7. Inventory spikes may not last
Energy investors watch U.S. oil inventories like hawks. Buildups suggest downside ahead for oil prices. But investors may be putting too much emphasis on this gauge right now. That’s because refiners have taken capacity off line for longer than usual this fall, says McDonald. (Taking capacity offline is a normal maneuver in the fall to switch refining capacity over to different kinds of fuel for the winter.) “As refineries are returning to normal, we should expect crude inventories to come back down from recent highs,” he says.
How to play rising oil
I’ve recently suggested Matador Resources (NYS:MTDR) and Encana in my stock letter around current prices. These are quality energy names where the insider buying is attractive.
Breard, at Hodges Capital Management, likes Helmerich & Payne (NYS:HP) , Ring (ASE:REI) , ProPetro (NYS:PUMP) , Solaris Oilfield Infrastructure (NYS:SOI) and Falcon Minerals (NAS:FLMN) , among others.
Morningstar has five-star ratings, its highest, on Cenovus Energy (NYS:CVE) and Energy Transfer (NYS:ET) . It has four-star ratings on Exxon Mobil (NYS:XOM) , BP (NYS:BP) , Royal Dutch Shell (NYS:RDS.A) , Eni (NYS:E) , Chevron (NYS:CVX) , Baker Hughes and Nabors Industries (NYS:NBR) , among others.
McDonald likes to go with exchange traded funds (ETFs). He suggests VanEck Vectors Oil Services (PSE:OIH) , Energy Select Sector SPDR (PSE:XLE) , United States Oil Fund (PSE:USO) and SPDR S&P Oil & Gas Exploration & Production (PSE:XOP) .
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested XOM, BP, RDS.A, HP, MTDR, ECA, PUMP, SOI, BHGE and NBR in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.