Energy stocks are 16 percent up this year, but they may not continue rising after the OPEC decision to cut oil production.
The announcement came after roughly three months of rising oil prices and speculation. The proposed cut to 32.5 and 33 million barrels a day, from 33.2 million barrels a day in August, confirmed that no one wants to continue pumping oil to a saturated market.
“We expected that the group would come together and make face-saving statements,” wrote Michael Cohen, Head of Energy Commodities Research at Barclays. “Certain countries in OPEC are at or near their peak already and would not likely be willing to crush the market by supplying more than is demanded.”
Energy Sector versus S&P 500 index (YTD)
The S&P 500 Energy index is up 16 percent compared with a 5 percent gain in the S&P 500 year-to-date. Shares of all major oil companies had considerable gains on a year-to-date analysis, between 11 and 15 percent for Big Oil companies Shell, Chevron, BP and Exxon.
The gains followed the hike on oil prices, which started moving up after reaching the lowest value in more than a decade January. Brent crude closed Friday at $49 per barrel, a 28 percent high year-to-date.
“The market did anticipate (the OPEC agreement),” said John Saucer, Vice President of Research & Analysis at Mobius Risk Group. “In the past few months, it was not just watching the OPEC, but it had found a floor. It said: ‘Ok, maybe $45 per barrel is tough, but it’s not $20.’ There was major optimism.”
The optimism came at a crucial moment. Low oil prices forced multiple layoffs at the energy industry. Shell’s profits fell by 72 percent in this year’s second quarter from the same period in 2015. In the same comparison, ExxonMobil’s earnings were 59 percent down, BP’s plunged 45 percent and Chevron’s fell 27 percent.
Energy sector versus Brent Crude Oil (YTD)
If the OPEC sticks with its promise, Brent crude prices could fluctuate from $55 to $60 per barrel in 2017, according to Evercore ISI. With a more conservative view, Goldman Sachs kept its forecast of prices around $43 per barrel by the end of 2016 and $53 per barrel next year.
But details on the agreement were left to be determined on the group’s next meeting, in November. Although stocks went up soon after the announcement, the gains were rapidly lost as questions were kept in the air.
“We see this more as an act of desperation,” wrote Commerzbank’s economists on Thursday. “We are confident that OPEC countries will not stick to the agreement.”
Analysts questioned when the agreement would come into effect, how they would verify compliance with it and how long it would last. They also criticized the granted exemptions for Iran, Nigeria and Libya. And pointed out that non-OPEC countries could increase their production if prices rise.
“The biggest risk factor, however, remains the potency of US shale,” wrote Allen Good, Energy Equity Strategist at Morningstar. “We expect any OPEC production cut and subsequent price response to be met with an acceleration of US activity.”
Morgan Stanley economists also warned that a cut in production by the OPEC risks stimulating the US production in a moment when prices are prematurely rising.
“We believe the clear winner with this decision is the US shale industry,” wrote the analysts.
On a year-to-date analysis, oil and natural gas explorers are the best performing shares in the sector. Oneok Inc. stocks are 102.43 percent high, Southwestern Energy Co’s are 98.45 percent up and Spectra Energy had gains of 73.31 percent. On the other hand, refining companies had the worst performances: Valero Energy shares lost 21.99 percent in value, Tesoro Corp’s are 21.77 percent down and Marathon Petroleum’s fell 17.98 percent.
For Evercore ISI, oil companies are in the “sweet spot” of the investment cycle. The bank cited rising oil prices, declining costs and stronger capital discipline to explain their bet.
“Significant earnings growth is likely in 2017,” wrote the economists. “We remain Overweight Big Oil. Our favorites remain Shell, BP, ExxonMobil and Chevron.”