Q4 Outlook: $100 WTI in Sight
September was bad for stocks. In fact, all three major indices lost ground during the month, breaking a 7-month long win streak. In all this, though, there was one bright spot, and it was in what most considered an unlikely place...energy. The sector ETF, XLE, is up 8.8% on the month as I write, as compared to the S&P 500 ETF, SPY, which is down 4.3% from the August 31st close. Of course, if you are a subscriber to Deep Earth Publishing, the outperformance of energy wouldn't have come as a surprise at all.
The energy sector as a whole includes some alternative energy companies and other non-oil stocks but ultimately, the price of oil is directly correlated to the sector performance. Some of you may remember that back in May, I wrote saying that I believed crude could easily hit $100 per barrel before the end of the year. We aren't there yet, but crude is up over 10% on the month, which is why XLE is outperforming by such a wide margin.
Back when I called for $100, WTI was trading just above $60, and I am sure a lot of people though I was crazy. Now, however, at $75/barrel, that psychologically important level looks to be in reach. Those of you who are familiar with my style might reasonably expect that, now that everyone believes in $100 oil, I will be changing my tune and calling for it lower. That would be reasonable and logical, but wrong.
I generally like contrarian trades, if for no other reason than that they offer a great deal of upside that can often be realized quickly. When everyone is short and something starts to move up, or vice versa, the covering trades add to the momentum, so if you can oppose conventional wisdom and be right, there is good money to be made. However, you also have to understand that sometimes the crowd is right, and this looks like one of those times.
Oil prices are in a perfect storm right now. On the supply side, the OPEC+ agreement has been renegotiated and ratified, restricting global supply. When those restrictions were first put in place, they were met with a big increase in U.S. output, keeping prices relatively stable. Now, though, U.S. E&P companies are holding back.
That could be for any of several reasons, or, more likely, a combination of them.
The Delta variant has caused a covid surge around the world, and the Chinese government has started to crack down on tech companies, crypto and all manner of things. Those two things combined have brought previous growth assumptions into doubt and put pressure on stocks. Add in a bit of a "once-bitten, twice shy" attitude from E&P firms after so many got burned the last time that they ramped up production , and spending to increase output based on projections of growth makes no sense.
Even if they wanted to increase output, however, now wouldn't be a great time for U.S. oil companies to do it. The Biden administration isn't as far left as some on the right would have you believe, but they are pretty committed to fighting climate change. Given that, further restrictions and regulations on oil production is always something they are prepared to offer to the far left when the inevitable internal squabbles of the Democratic Part surface. So, with already restrictive regulations of oil production and transportation in danger of being tightened even further, expansion by oil companies is virtually impossible.
And yet, those oil demand growth expectations are looking more realistic every day.
The Chinese government has a long history of "cracking down" on anyone or anything that it feels is growing too big or too fast for the party to control. For the last decade or so, though, those crackdowns have been largely symbolic, brought in with much fanfare, then quietly reversed over the next few months. They aren't designed to change things, just to send a warning. Chances are, this one will be no different. The government will make their point, but won't put too much pressure on economic growth.
As to the covid issue, it's not that I don't think it is a problem: it clearly is. It's just that no one seems to care. The spread of Delta is now overwhelmingly concentrated among the unvaccinated and there is an increasing feeling among the vaccinated that those who refuse the vaccine are getting their just desserts. They are not about to go back to restrictions that they see as designed to help those who refuse to help themselves.
That is how you get to a point where, even as ICUs in some parts of the U.S. are full to capacity and beyond, help from elsewhere is limited. It is also why, even as the pandemic continues to resurge globally, stories like this can be found, stating that the G7 nations are about to come to an agreement regarding the reinstatement of international travel.
All of those factors combined are why, as I write, oil is significantly higher on the day, even though the S&P 500 is collapsing on worries about growth. Those concerns should impact crude too, but they are speculative, whereas increasing oil demand and tight supply are real right now, and don't look like ending soon.
So, even though it is no longer a shocking thing to say, I will reiterate what I said back in May... WTI is headed to $100. That is why, as we move into the fourth quarter, I am staying long oil stocks, including the broader based XLE, and adding to my positions every time crude wavers and loses a couple of points.
Cheers,
M
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