Investors in the oil sector seem skeptical - should you do the opposite then?

Mikael Syding
02.09.2020 | 3 min lukea

Four months ago I wrote about the extreme contango structure in the oil market (The right price for oil, 6 May 2020). My message was above all that the oil price must rise quickly in order for you as a buyer to make money on the deal. Much has changed since then.

Four months ago I wrote about the extreme contango structure in the oil market (The right price for oil, 6 May 2020). My message was above all that the oil price must rise quickly in order for you as a buyer to make money on the deal.

Much has changed since then. Concerns about the Covid-19 pandemic have abated, parts of the world economy have recovered and key stock markets have risen to new historic highs. The oil price also signals more or less the danger, even if the situation is always a little more complex than that.

WTI Oil 2015-2020

Oil WTI 5 yr

At the beginning of May, the oil price was lower than half the current price. The price for the June contract was then 18.77 dollars per barrel, and for example the September contract cost 25.64 dollars. Today, September 1, the October contract for WTI oil is exactly 43 dollars per barrel, and the contango per month is just under 30 cents per barrel, compared to a full 3 dollars for the next month at the time of the previous guest article. The spot price was depressed due to concerns that the economy would be weak for the foreseeable future due to the Covid crisis and the acute problem of full oil stocks.

The situation is not yet fully under control, inter alia, because the economic strength is dependent on continued economic and monetary stimulus. The WTI price looks in a five-year weekly chart to meet strong resistance here at $ 43 a barrel; a level that several times before in the last five-year period constituted a de facto bottom for the price. The question is whether the underlying flows and fundamental driving forces are strong enough to cause the price to break upwards from here.

Regardless of which direction the price decides to go, the probability is high that the movement will be significant. However, I think there is more to a price drop than a squeeze upwards. Throughout the upturn, the price has followed its own 20-day moving average very closely, and was mostly just above. However, the rise has stopped almost completely, at the same time as price changes have become remarkably small. The oil market therefore feels artificial and sensitive. In time for the monthly rollout on September 20, the price graph also meets its 50-week moving average (falling black line), which could trigger a price decline. This is especially true if the economic statistics for August, and the outlook for September, should come as a negative surprise.

The development for individual shares in the sector hardly gives any reason to buy either oil or oil shares. Of course, the valuation multiples for companies such as Exxon, Chevron and Conoco are quite low, although not super cheap in a historical comparison. But overall, the price graphs give the impression that oil investors have only reflexively benefited from a temporary bounce in the sector and have already begun to rotate out of the cyclically sensitive sector. The oil services ETF, the OIH, looks particularly vulnerable with a relatively large head shoulder formation formed over the past 6 weeks, which is also reflected in Schlumberger's course. Halliburton has almost quadrupled to just over $ 16 / share since bottoming out in mid-March, but is still far from the $ 25 high in January. Halliburton has also been meeting its declining trend for several years now.

Industry professionals therefore do not seem to believe in much higher oil prices, but rather plan for at least a clear downward correction soon, and possibly a more sustained negative movement, should it turn out that the economy stops responding to Trump and Powell's attempts to whip up the economy as if it were a half-dead horse. It is not easy to choose a side in the oil sector, but as a salesperson here you at least avoid the ongoing gamma squeeze in technology companies, while you get exposure to a potential and relatively likely downward turn. On the other hand, the US presidential election on November 3 speaks for more stimuli than ever in the coming months, while the economies and also travel are opening up more and more, which can benefit all cyclical investments, including oil and oil companies.

@Mikael Syding

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