Crude Oil Rides The Roller Coaster

It was only a month or so ago that I began advising investors to ease up o...

Crude Oil Rides The Roller Coaster By Robert Rapier It was only a month or so ago that I began advising investors to ease up on certain energy stocks. Some had risen 20%-30% since the beginning of the year, and were starting to look fairly valued. Fast forward a month, and the picture has changed. The front-month West Texas Intermediate (WTI) crude contract ended May over 16% lower, which marked the first monthly loss of the year. Most energy stocks have followed oil prices down. What has happened, and is this now a buying opportunity for energy stocks?

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What's Driving Oil Prices? There are two things going on. The first is that it is becoming apparent that the trade war with China will be lengthy. There are fears that this will impact oil demand there as well as here. Add to that Friday's announcement by the Trump administration of plans to impose a 5% tax on all goods imported from Mexico unless "the illegal migration crisis is alleviated." These tariffs would potentially rise to 25% by October. This sent a chill through the stock markets and the oil markets, with WTI losing more than 5% on the day. The global oil demand picture has been mixed in recent months. The International Energy Agency (IEA) reported that oil demand numbers for the January-February period in China grew by 410,000 barrels per day (BPD) year-over-year. India's demand grew by 300,000 BPD, and U.S. demand was close behind with 295,000 BPD of growth. But oil prices impact demand, and they have risen sharply since January. This, along with the trade war, may explain more recent reports that overall oil demand in China had declined by 0.3% year-over-year in the first quarter. That brings me to the second factor that I see unfolding in the oil markets. Every time demand in China slows down, there's a rush to push the narrative that it's because electric vehicles (EVs) are finally starting to take a bite out of oil demand. This explanation promotes the fear that crude oil will soon end up like coal, which in turn helps push oil prices lower than they should be. Bloomberg recently projected that oil demand in China will peak in 2025 as a result of EVs. The Outlook for Investors So, what's an investor to do? Let's consider a few things. First, Bloomberg also recently reported that energy stocks now account for only 5.02% of the S&P 500, which is less even than in early 1999. Notably, at that time oil prices had collapsed to $10/bbl and the tech bubble was depressing the share of all other sectors. Consequently, a 5% energy share today seems to be a significant historical disconnect. In other words, energy stocks are likely again undervalued. Second, we should consider the different segments of the energy sector. When oil prices fall, typically oil producers get hit the hardest. Pipeline companies usually take a milder hit, and refiners often benefit because their margins expand.

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That hasn't been the case. At least not entirely. Two top oil producers, ConocoPhillips (NYSE: COP) and EOG Resources (NYSE: EOG) saw declines in May of 3.8% and 8.2%. That's especially modest considering the double-digit drop in oil prices. Midstream companies held their ground. Enterprise Products Partners (NYSE: EPD) fell by 2.5% in May. Magellan Midstream Partners (NYSE: MMP) was one of the few energy companies that rose during the month (+1.1%). The supermajors Chevron (NYSE: CVX) and ExxonMobil (NYSE: XOM) saw respective declines of 2.2% and 8.4%. Incidentally, this puts Chevron's yield above 4%, which has historically nearly always been a good buy indicator. But the big story is the refiners. The nation's two biggest refiners, Marathon Petroleum Corp (NYSE: MPC) and Valero (NYSE: VLO) saw shares decline by 21.6% and 20.2% respectively. Valero's yield has risen to a whopping 5.1%. Refiners often trade out of sync with oil prices, but this time the concerns about overall demand, and higher-priced oil from Mexico as a result of tariffs, hit the refiners hard. Trade tariffs on Mexico could be a double-whammy if the country retaliates, because U.S. refiners send large volumes of finished products back to Mexico. Deep Bargains Among Refiners Most segments of the energy sector are relatively more expensive than they were a month ago, considering the large drop in the price of oil. If the price remains in the current range for very long, oil producers and integrated oil companies will likely see larger declines. The midstreams started the year undervalued, but after a large run-up many of them had reached fair value. Magellan Midstream was an exception, because it hadn't gained as much as many of its peers. The stock was overdue; its May gain went against the rest of the energy sector. All things considered, refiners are unlikely to suffer as much as the market fears. Further, lower oil prices will help lift gasoline demand, and should help prop up margins. Right now, refiners appear to have become bigger values. Overall, though, the broader stock market is suddenly in turmoil, thanks to slowing global growth and the escalating trade war. Worried about the spike in market volatility? For answers, turn to my colleague Jim Fink. Jim Fink, chief investment strategist of Velocity Trader, has devised a trading system that racks up market-beating gains, regardless of the gyrating price of oil, trade tensions, or economic ups and downs. Jim achieves consistent trading success via his proprietary trading system, called the Velocity Profit Multiplier (VPM). The product of painstaking trial and error, the VPM can predict when a stock is about to rise, or fall, with uncanny precision. Jim's VPM has now unearthed a trade that could generate up to 172% in quick profits. Click here for a free presentation.

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