Oil prices moved sharply higher over the past three weeks. West Texas Intermediate (WTI) crude has jumped from the mid $40s to the mid $50s. A sense of euphoria is permeating the sector as investors breathe a sigh of relief. The consensus is that all is well again in the oil patch.
But nothing could be further from the truth…
The stars indicate we’re in a trader’s market. Both of my recent picks, EOG Resources (NYSE:EOG) and Synergy Resources Corporation (AMEX:SYRG), have rallied sharply with the rest of the sector.
Reality will set in soon, though. Many won’t see it coming, but oil shares are going to start trading lower soon.
Seeing the Signs
If – like so many market commentators are saying these days – the recent oil crash was just a flash in the pan and recovery is right around the corner, then many veteran oilmen are going to be eating a lot of crow.
You see, these captains of the industry own the companies at the top of the oil food chain. They’re the ones most affected by and most aware of longevity and profitability. Their actions speak louder than any words, and right now, they’re preparing for a very long period of lower prices.
The CEOs of oil majors like Exxon Mobil (NYSE:XOM) and British Petroleum (BP (LONDON:BP)) both said publicly that they expect lower prices for some time.
Exxon’s CEO, Rex Tillerson, has a much more bearish take on oil prices. Speaking at IHS’ CERAWeek conference in Houston, Texas, Tillerson predicted that oil prices would remain subdued for the next several years.
The CEO of ConocoPhillips (NYSE:COP) stated that he’s worried there are too many wells awaiting completion. Once they come online (as a result of higher prices), he thinks the pressure will send prices lower, once again.
It’s really a classic prediction of the boom and bust cycle.
Now, if only one or two CEOs were just musing about oil prices, I would be skeptical. But they’re putting their money where their collective mouths are and cutting back spending by double-digit percentages!
And they’re not the only ones…
Major drilling and oil service companies – like Schlumberger (NYSE:SLB) Halliburton (NYSE:HAL), and Baker Hughes (NYSE:BHI) – are laying off tens of thousands of employees as a result of lower spending by oil companies. They’re also working to reduce their margins in order to remain competitive bidders.
Before you panic, lower prices do not mean we’re going back to $20 per barrel. Prices could very well stay at the lower prices they’re at now, trading between $40 and $60, for some time to come.
Conditions Just Aren’t Right
On the flip side, you might be wondering if all of this reduced spending, drilling, and completion activity could lead to supply constraints, which could trigger higher prices.
But, there are three factors that need to fall in line before that’s a real possibility.
First, the amount of oil in inventory has to be worked through. The supplies are at all-time highs – 500 million barrels are just sitting in tanks, pipelines, and other storage facilities. And more is being added daily.
Second, the Saudis need to stop producing at record-high levels and flooding the world with excess crude.
Third, the wells that are slated for completion won’t be forgotten. There are thousands of them sitting idle, just waiting for higher prices. And, you can bet the producers will lock in higher prices through hedges as fast as they can in order to secure future cash flow.
Until these three “issues” are worked through, oil prices will continue to have a downside bias, despite any short-term rallies.
That’s the reality that the insiders in the industry are betting on.
Their actions are worth paying heed to before you decide that a bull market in energy is back in the cards again.
And the chase continues,