Is It Time To Start Buying Oil Stocks

There Is A Case To Be Made For Oil Stocks

WTI began its sharp decline with the onset of China’s coronavirus outbreak and is now down -20%. The price of WTI is bouncing from support targets in today’s early action but there is little sign of a reversal in price action now.

With oil prices on the verge of full-blown bear market and oil stocks following them lower a buying opportunity is in the making. The question is whether now is the time to start buying or not. Based on factors like supply & demand, OPEC, the earnings outlook, there is a case to be made but it’s not bullish. Not yet.

A Well-Supplied Market

The coronavirus added an unknown element to the global oil demand outlook that has yet to be resolved. The EIA expects demand to rise by 1.3 million bpd in 2020 but that will be more than met by supply. Supply is expected to increase by 1.6 million bpd and will come from primarily non-OPEC countries.

This situation leaves OPEC in a quandary, what can they do to increase prices and not lose market share. Selling oil at a higher price is one thing, selling less oil at a higher price is another. The cartel’s technical panel is meeting now, February 4th and 5th, to discuss the potential impact of the virus on demand. They are largely expected to make recommendations are whether to extend or deepen current production cuts.

OPEC production has been falling for three years since hitting a peak in late 2016. In that time, oil prices have rebound from a ten-year low but only a fraction of what they lost to hit that low. In more recent memory, prices have wallowed within a range for the last four years and look like they will be heading lower. Bases on the non-supply OPEC supply outlook there is little the cartel can do to shore up prices short of a major supply disruption.

The Earnings Picture Is Cloudy

The outlook for energy sector earnings is robust but there is a caveat and a dark cloud to worry about. The caveat is that earnings in the energy sector, as represented by the XLE Energy Select Sector SPDR (XLE), will grow EPS by 23.7% in 2020 but only after it fell by 30% in 2019. Not much growth if you ask me, more of a rebound that falls short of the target, and includes the impact of massive share buybacks within the sector. Earnings growth will continue in 2021 as well but it decelerates to a mere 8%, barely enough to recover “lost glory”.

The dark cloud is the economic impact of the coronavirus. The estimates for the forward earnings have already come under pressure and are likely to tick lower in the coming weeks. China has shut down large portions of its economy due to the virus and it is not the only one. Industry across Asia is feeling the impact of restricted travel and closed business. A sustained period of lower than expected oil prices will drag on the earnings outlook. If oil prices continue their decline we can expect EPS growth to all but disappear.

The Technical Outlook: Bearish With A Chance Of Rebound

The XLE Select Sector SPDR set a new four-year low with today’s action. The trend is down and the indicators are pointing lower so a decline in prices is suggested. Today’s candle shows some signs of support at this level but, so far, no rebound has materialized. The next targets for possible support, should this one fail, are near $52 and $50.

The risk is that OPEC will actually produce a large enough cut to boost oil prices. If so, the XLE may begin to rebound but even then the outlook isn’t all that great. A production cut large enough to goose the market will likely be short-term in nature and provide limited support to prices. Once the cut expires fundamentals will return to oversupply, oil prices will fall again and so too will the outlook for energy sector earnings.