Yesterday's news that OPEC sort of, kind of, had an agreement to limit oil production should be seen as a sign that there is a pretty firm floor on oil, but not an outright bullish sign.
Last year I suggested that OPEC would signal production limits at about 32 million barrels per day. I was a little low, they're talking 33mbd. Close but no cigar, although the concept is right. Here's what I see for energy investors.
With Iran wanting to pump more oil, as well as, disruptions in Libya and Nigeria that will someday be remedied, and the imminent IPO of Saudi Aramco, the more realistic eventual OPEC cap number appears to be around 34-35mbd.
Investors should not dismiss OPEC. It is still very relevant and that they will continue to exert influence on oil production. Protection of market share will remain a focus long-term for OPEC. Over the next year or two, they also want to raise the price of oil to the $70-80/barrel range.
OPEC (and Russia) want oil prices to rise without causing major competition to emerge. To do that, they have to make it clear that they are still willing to flood the oil market in order to keep many deep water and oil sands megaprojects from being built. Those are the projects that create long-term market share competition that OPEC doesn't want to continue.
I believe that OPEC is already making an implicit threat to big oil. If big oil starts investing in deep water and oil sands megaprojects again, then OPEC could very suddenly open up the spigots again.
Those financing megaprojects had better be warned that there is no magic to make those projects economic again. Demand growth in oil is flattening and never likely to rise quickly again with the advent of EVs. Supply in the intermediate term is sufficient to keep oil from spiking in price short of major disruptions.
Will OPEC's implicit threat to megaprojects ever become explicit? My guess is that eventually it will be said, but unofficially.
For those who would invest in oil stocks, it is clear that we must stick with the low cost producers. That means focusing on companies that have assets in places like the Permian Basin of Texas, which has probably the cheapest American oil to extract.
It also means we need to think very seriously about "whether oil is where our energy focus should be?"
OPEC & American Oil Majors
While OPEC's actions are important for establishing a floor price in oil, it does not signal a boom in oil. Rather, it signals that there are some producers who we can focus on for profits, but we don't want to dive into the industry head first. In particular, we don't want to buy into oil majors with trapped legacy assets and we don't want to invest in service companies that are focused on deep water.
Let's take a quick look at the two American oil majors I get asked about, Chevron (CVX) and Exxon (XOM).
I am rating Chevron. It has legacy assets that will never produce. It is also a government target for taxes. Chevron's global legacy is not serving it well (pun intended) at all. They have stalled out on production all over the globe and will be challenged to sell many of its assets at strong prices.
Technically speaking, Chevron's stock is turning over after a recent rally. It won't take much to push the stock down from $102 to about $96 where its 200 day moving average is. If it pierces that level, Chevron can go all the way down to its financial crisis lows in the $70s. It will take a catalyst to make that happen, but the list of potential negative catalysts is not short.
Chevron's fight with Ecuador over a $9.5 billion judgement is likely to end in a large payment. A little background on the case. Chevron dumped millions of gallons of toxic waste into Ecuadorian streams and rivers. They admitted to it and submitted to Ecuador's jurisdiction. After losing the case they sold their assets in Ecuador and have refused to pay the judgement.
Why should Chevron avoid a large legal liability they admitted to if BP couldn't in the Deep Water Horizon case (see note below about the movie)? They shouldn't be able to avoid this liability. In the end, they probably won't be able to avoid a multi-billion dollar payment to Ecuador regardless of what a Canadian court decides soon. While the Ecuador liability might be the biggest case against Chevron, it's not the only one.
Exxon is not too different from Chevron. However, it does not have the massive legal liability right now. Although that could change if there is ever a successful lawsuit that they hid climate change evidence.
The global assets of Exxon are impressive. However, there is a question as to whether they will have the cash flow to support their dividend. I expect they will attempt to sell assets, however, many assets will be sold at bargain prices to national oil companies.
Exxon stock has recently headed lower after a good run up. It has already breached its 2000 day moving average. As such, it is not a buy, however, for those who own it, it might be a hold. If Exxon has to tighten up its dividend policy, reduce buybacks or runs into execution stumbling blocks, the stock could fall as far as the $60-$70 range again.
In general, for those without Exxon stock, I'd just avoid it. There are much better investment prospects.
Focus on Natural Gas
As you know I am bullish on natural gas. The main reasons are:
- Increasing demand due to the demise of coal
- Constrained supply due to project delays and cancellations
- Exports from facilities on the Gulf Coast
There are several natural gas stocks that are fundamental leaders, however, many are a bit overpriced at the moment. The First Trust Revere Natural Gas ETF (FCG) is a fund that is worth buying as a diversified piece to a portfolio. By scaling in, an investor can get exposure to the natural gas sector from E&Ps to pipelines.
The thing to keep in mind about FCG is that you still get adequate exposure to oil. With only a few exceptions, the E&Ps in this ETF do have oil production. One of the top ten holdings has 10,000 wells in the Permian and a rapidly improving balance sheet. It is on our Very Short List of stocks to consider.
OPEC's Impact on Solar & Alternative Energy
I am also bullish on solar. With OPEC essentially putting a floor under oil prices that is bullish for alternative energy. But that's not the only factor leading to an alternative energy future.
The pressure from governments to slow and stop global warming is massive. The Paris Climate Agreement of 2016 changed international law. That agreements guarantees that the trend will continue to be towards renewable energy.
While many would point to wind, geothermal and hydroelectricity as core alternative energies that would threaten the continued emergence of solar, they are wrong. The reality is that solar has huge advantages to all three of those options. Key among solar's advantages to other forms of energy are:
- Once a utility scale project is finished, there are very low operating costs
- For new energy production, solar is already about the same price as new coal and natural gas plants
- The moving parts and unpredictability for wind energy make it a second choice
- Geothermal is not available affordably in many places
- Hydroelectric is near its bounds as water rights come into play
- Solar just keeps getting cheaper, so subsidies won't matter by the 2020s
OPEC and Energy Investing
OPEC continues to impact energy investment. That won't change until electric vehicles are taking real market share from ICE vehicles.
Where the biggest opportunities in energy lie are a handful of oil stocks, a group of natural gas stocks and the leading solar stocks. Subscribers will continue to pick up positions from our "Very Short List" and our "ETFavorites."
Keep a slow hand. Don't get an itchy clicker finger. Scale in. Focus on position sizing and building a good asset allocation.
And, always remember to ask yourself this question: "In 5 years, what will I wish I bought today?" It's a great question and will help prevent blowouts.
On the blowout note, I went to see "Deep Water Horizon" on Tuesday at a preview. Folks, it's on the short list of movies that you have to see this year - along with "The Big Short" from springtime. I won't spoil anything for you, but if you don't come away moved and thinking about priorities, well then, I'm no Marky Mark after all.