The Oil Patch Is Starting To Look Attractive

Mark Nuckols
Posted: Jan 11, 2016 9:44 AM
The Oil Patch Is Starting To Look Attractive

There is a lot of pain in the oil patch right now. Producers everywhere are hurting badly as oil prices continue to make new 11 year lows. But their pain could turn out to be your (financial) gain.

Many predications about the future price of oil turn out to be comically wrong. In 1999 the Economist magazine ran a cover story heralding the era of $10 oil, just as oil was beginning a steady decade long rise to $140 a barrel. Right about the time oil peaked at $140 in 2008, the CEO of Russian energy producer Gazprom boldly predicted a price of $250.

I am going to go out on a limb and call this the bottom of the current oil price decline.

It’s January 11, 2016 and West Texas Intermediate is a shade above $32. Now, let me add two caveats. When Iran resumes increased production in the next month or two, oil may make one more leg down. And the price could remain at current depressed prices for a while. But if we’re not at the very, very bottom, we’re awfully close. And now is the time to start overweighting oil stocks.

The oil market is very sensitive to the balance of supply and demand. Global oil (and petroleum liquids) is about 96 million barrels a day, while supply is running about 97. And inventories have been hitting new records on a regular basis. So there’s oversupply.

On the demand side, China has dominated the headlines. Dramatic drops in the Chinese stock market reflect worries that the Chinese Growth Machine is slowing down, which would lead to a reduction in China’s voracious appetite for oil and other commodities.

However, with prices in the low 30s, a lot of that 97 million barrel daily supply is simply unviable. High cost producers are already starting to shut in their more uneconomical wells, taking supply off the market. Sooner or later this reduction in supply will filter down into lower inventories and firmer prices.

Also, market sentiment is overwhelmingly bearish. The net long position in oil futures in at a five year low. Basically, the bulls are throwing in the towel while the shorts are piling in. This could set the stage for a sharp rally once the demand-supply equation comes back into balance. Oil is a classic contrarian bet at the moment.

So how to get greater exposure to the oil patch? One simple and efficient way would to be purchasing shares in Fidelity’s Select Energy Portfolio. On Friday it closed at 32.63 a share, not far from the 28.44 low during the heights of the financial crisis. (In the frothy days of 2008 it got as high as 76.04, and in 2013 reached a post-crisis high of 63.39) When the SP 500 bottomed at 666. The broader market has tripled since January 2009, while this fund is up a measly 15% from the darkest days of sheer panic and fear.

The portfolio is comprised of producers, such as oil majors ExxonMobil and Chevron, and oil services companies like Schlumberger and Baker Hughes. These are world class companies with strong balance sheets. They will be the survivors who lead the consolidation of the oil industry while weaker players fall by the wayside, either acquired or liquidated in bankruptcy.

These companies also are well managed, which gives them crucial advantages in a global oil market where their competitors are often woefully mismanaged state oil giants. Long term they will prosper. The fund itself has 1.76 billion in assets and pays a 1.10% dividend.

So if you’re super cautious (or greedy) you might buy this fund (or individual oil stocks) at cheaper prices if you wait. But I don’t think they’ll get all that much cheaper, and you may risk missing the move up. And of course, any investment has risks. But long-term, having well managed blue chips in a critically important industry in your portfolio isn’t a bad strategy to follow.