Oil prices have been on a tear, with crude oil rallying 25% from its lows in August to above $50 a barrel.
At the same time, many of the best-performing stocks have been battered energy companies that had been left for dead. There are a host of double-digit gainers in the oil patch over the past 30 days as the benchmark S&P 500 Index has been little changed: from midstream master limited partnership like Plains All American Pipeline PAA, +0.80% to oil-field-service company Halliburton HAL, +4.25% to even scandal-plagued Brazilian oil giant Petrobras PBR, +0.93%
But while some analysts are bullish on oil and oil stocks, the reality is that we are in store for yet another head fake in the energy sector. While crude oil has indeed rallied nicely recently, many times in the past year or two we’ve seen those rallies fall apart and end in tears.
I’m not buying oil or oil stocks, and neither should you. Here’s why:
OPEC is all talk: Once again, we are seeing a bunch of headlines about how OPEC is getting serious about curtailing production. But once again, many investors are failing to think critically about the situation. For starters, any progress on production talks is not progress on actually reducing oil output. Remember in spring, with the Doha deal that never happened when Iran refused to lower production goals? Keep that in mind — and also keep in mind that only Russia has gone on the record saying it will cut, while Mexico and Norway flat out have refused. Just as we saw prices collapse as negotiations collapsed before, we will see it happen again.
U.S. production still high: It’s true that U.S. oil output has tailed off in the past year, with weekly output down to about 8.5 million barrels of petroleum, according to the U.S. Energy Information Administration, from a peak of about 9.6 million in the summer of 2015. However, keep in mind that the current level is still on par with the average weekly output of 8.5 million barrels in calendar 2014. Five years ago, the average weekly output was only 5.6 million.
Urgency to pump: Any short-term drop in production cannot be a sustained trend simply because many smaller energy companies face crippling debt obligations. After all, just this summer junk-bond defaults hit a six-year high with ratings firm Fitch reporting a 15% default rate for the energy sector and a whopping 29% default rate for junk bonds in exploration and production. Sure, some companies have pulled back. But many others are operating at maximum capacity simply to keep the lights on, regardless of OPEC or pricing trends or macro themes.
Demand is going nowhere: All this fixation on supply ignores one simple fact that many oil watchers haven’t truly acknowledged: We are in an era of weaker demand growth, owing to the current stagnation in the global economy and the continued focus on efficiency and carbon emissions. The International Energy Agency revised down its 2017 forecast (again) in August. Furthermore, some analysts think China’s supposed rebound in appetite after nearly a nearly one-year low in demand was driven by stockpiling after oil prices rolled back again in August — not a sustained recovery in actual consumption. The sad reality is that many emerging markets just don’t have the booming growth that demands lots of oil, and most western markets are looking to alternative energy and natural gas.
Stronger dollar looms: Commodity prices have an inverse relationship with the dollar, and it’s hard to imagine the dollar going anywhere but higher in the next year. As Europe deals with Brexit fallout and both the European Central Bank and Bank of Japan are engaging in extraordinary monetary stimulus at the cost of their own currencies, the dollar looks mighty favorable by comparison. And while I remain skeptical that the Federal Reserve will ever be able to truly see sustained “liftoff” in interest rates over the long term, the hawkish language recently by some like Boston Fed head Eric Rosengren does hint that at least one rate boost is in the cards for 2017. That will drive up the dollar, and act as a headwind on crude oil.
Oil is not the future: Many of these short-term factors can, and will, change in the coming months. But the secular decline of crude oil as the lifeblood of the world economy is a trend that cannot be counteracted. Just as the world has already moved in large part away from coal, fossil fuels in general are not growth industries. Consider that about 28% of energy in America goes toward transportation, and that in a few short years we’ve already moved from hybrid automobiles to the mainstream adoption of electric cars that use the grid, not gasoline. I’m not saying oil will disappear overnight, but the narrative of the next decade is not favorable to this energy source, and any positive developments for crude oil will have to fight against the very real headwinds at play in the long run.