Oil has become the most talked about economic factor over the past year resulting in stock market forecasts that range from the next great under priced commodity to the end of the oil industry. Both sides of the discussion provide opinions and estimates from experts that logically and rationally provide a convincing argument.
Let’s examine the facts.
The Energy sector represents 7% to 8% of the market but, crude oil pric-ing impacts every aspect of the market either directly or indirectly. Too much of the analytics published focus on a daily time period. That may be useful if you are a commodities trader or trying to decide on timing of your next fuel oil delivery. However, on the longer term investment side the considerations for time should be longer and focus on a reasonable forecast. In order to make some sense of the market let’s focus on old fashion demand, supply and price.
The two charts below show the past several years relationship between demand and supply. We are looking at a world demand and supply because oil is a global product that enjoys few restrictions in delivery and has universal demand. You can immediately see the steady demand for this precious raw material since 2013 with just temporary dips in the first two quarters of each year. The overall demand has been steadily upward at about a 0.44% average per quarter increase and expected to slow slightly going forward to a 0.32% average per quarter rate. Supply has been increasing of recent at a 0.64% per quarter average. If the rate for both sup-ply and demand were to continue, prices would be very soft into the foreseeable future.
Fortunately, supply should slow as energy companies continue to push capital expenditures into the next 36 months and marginal suppliers either slow down or discontinue future operations. Demand should increase in the next 12 to 24 months as lower energy prices create better margins that result in either increased non-energy related capital expenditures or higher profitability. The energy recovery is similar to real estate cycles where boom times create oversupply followed by a period of demand/supply normalization, followed by a rapid expansion. It appears we are midway through the demand/supply normalization period to be soon followed by an energy boom.
World Oil Supply & Demand 2013—2016 estimate
International Energy Agency, Oil Market Report
The pricing relationship is clear when compared to supply/demand ratios. The chart below shows West Texas Intermediate (WTI) pricing at various ratios over time.
Crude Oil WTI 2009—2015 October, NYMEX
Normal pricing, if there is such a thing, is considered to run between $50/bl on the low side and $90/bl on the high side. When de-mand was exceeding supply, pricing was exceeding $100/bl on a regular basis. Even as recently as early 2013 when the demand/ supply rate was 99.1% prices hovered around $105/bl. Now that the rate is 101.6% prices have fallen to $44.84/ bl. The interesting thing about oil is that it does not take a large spread between supply and demand to move the price significantly. This is why the end retail price for energy can make a large difference in overall economic growth.
Energy’s earlier move to the upside this month, which was directly related to the major providers, is now being followed up by some of the smaller players: Southwestern Energy (SWN), Kinder Morgan (KMI), EQT Corporation (EQT) and Range Resources (RRC).
Three of the Fast Movers are coming in from Health Care (XLV) which is continuing to move closer to fair value at 90.2% FV. The Health Care contributors are: Tenet Healthcare (THC), Universal Health (UHS) and AbbVie (ABBV).
Under Armour (UA) remains as the most overvalued stock at 184.04% FV which is slightly less overvalued than previously. However, market expectations far outstrip any reasonable expectation for earnings and/or growth within the company directly. Stock speculation is at least 54 percentage points of the stock’s market value.