Technically Speaking: Is The Rally in Oil Sustainable?

Technically Speaking: Is The Rally in Oil Sustainable?




by Lance Roberts, Clarity Financial

I have been getting a tremendous number of emails as of late asking if the latest rally in oil prices, and related energy stocks, is sustainable or is it another “trap” as has been witnessed previously.

With geopolitical turmoil mounting, for North Korea to Iran, and as natural disasters have rocked the refinery capital of the world (Houston,) the question is not surprising.

As regular readers know, we exited oil and gas stocks back in mid-2014 and have remained out of the sector for technical and fundamental reasons for the duration. While there have been some opportunistic trading setups, the technical backdrop has remained decidedly bearish.

Today, I am going to review the fundamental supply/demand backdrop, as well as the technical price setup, as things have improved enough to warrant some attention. As a portfolio manager, I am interested in setups that potentially have long-term tailwinds to support the investment thesis. The goal today is to determine if such an environment exists or if the latest bounce is simply just that.

Let’s get to it.

With OPEC discussing the extension of oil production cuts into 2018, the question is whether such actions have made any headway in reducing the current imbalances between supply and demand? This is an important consideration if we are going to see sustainable higher prices in “black gold.” 

With respect to the oil cuts, the current cut is the 4th by OPEC since the turn of the century. These cuts in production did not last long, generally speaking, but tend to occur at price peaks, rather than price bottoms, as shown below.

Despite the occasional rally, it’s hard to see that the outlook for oil is encouraging on both fundamental and technical levels. The charts for WTI remain bearish, while the fundamentals seem to be saying Economics 101: too much supply, too little demand. The parallel with 2014 is there if you want to see it.

The current levels of supply potentially creates a longer-term issue for prices globally particularly in the face of weaker global demand due to demographics, energy efficiencies, and debt.

Many point to the 2008 commodity crash as THE example as to why oil prices are destined to rise in the near term. The clear issue remains supply as it relates to the price of any commodity. With drilling in the Permian Basin expanding currently, any “cuts” by OPEC have already been offset by increased domestic production. Furthermore, any rise in oil prices towards $55/bbl will likely make the OPEC “cuts” very short-lived. 

As noted in the chart above, the difference between 2008 and today is that previously the world was fearful of “running out” of oil versus worries about an “oil glut” today.

The issues of supply versus price becomes clearer if we look further back in history to the last crash in commodity prices which marked an extremely long period of oil price suppression.

Despite the rising exuberance as money chases the “beaten up” energy stocks on a sector rotation basis, ultimately, it always comes down to supply and demand.

Reviewing History

In 2008, when prices crashed, the supply of into the marketplace had hit an all-time low while global demand was at an all-time high. Remember, the fears of “peak oil” was rampant in news headlines and in the financial markets. Of course, the financial crisis took hold and quickly realigned prices with demand.

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