Energy stocks adjust for medium term pain

While surveys suggest that a majority of analysts anticipated that the OPEC meeting would not reduce its production quota, today’s market action indicates that traders and investors went in to the meeting attaching a reasonable probability to OPEC cutting production. Instead, investors in energy stocks are this morning pricing in the possibility of sustained weakness in the oil price and a scenario in which excess supply capacity might persist for the next year or two.

Supply overhangs in commodity markets make market momentum difficult to assess for investors. It’s not unusual for markets to stay over supplied for longer than expected. Consequently prices can fall further than many expect.

While today’s large drop in both oil prices and energy stocks might turn out to have been amplified by Thanksgiving holiday in the US and thin volumes, it does seem likely that OPEC’s decision creates the potential for a lower range of oil prices for some time to come.

The situation with oil is complicated by ever-present global political risk. The world is still not immune from a situation that where conflict could see large amounts of supply incapacitated. The lower the oil price gets, the more vulnerable it becomes to geopolitical risk

In the longer run, oil companies with good quality, low cost production capability and strong balance sheets will be the ultimate winners. Investors will be thinking about the right entry point for these stocks.  Today’s OPEC decision means that new oil projects will be difficult to justify and finance for some time. There is also likely to be a decline in exploration activity. Oil prices will need to return to around $100 to support the production increases that will still be needed in the long run creating a solid outlook for low cost producers.   

For further comment from Ric Spooner please call 02 8221 2137.