Some Thoughts on the World Energy MarketI will be the first to defer to Migraine's expertise on the world energy market and the amount of research he puts into it. When I look at all this, I look at the big picture and the motivations of the big players involved. The stock market is as much phsycological as it is analytical and it is important to look at it that way when deciding what to do.
So - what do I see?
Oil Price Backwardation
In simple terms this means that the future price of oil is less than the current spot price. What does this mean? In essence it means that the big oil traders believe that there is a recession coming and the price of oil will fall because of that.
If they are right and there is a recession then the SP of all stocks will fall and because oil prices will fall, the SP of SU will go down from current levels.
Inventory Fluctuations of Oil
Oil traders have a lot to do with the level of oil inventories. Their decisions are based on a number of factors - the future price of oil compared to the current cost; storage costs and interest rates to name the main ones. With the oil market in backwardation and rising interest rates, it is difficult for oil traders to make the math work to buy oil today and make money by hedging through the purchase of oil futures. Similarly, oil producers, especially shale producers, are not able to hedge future production at higher prices than the current spot price and so provides a disincentive to produce more oil.
Backwardation has decreased in the last month but interest rates have gone up, so there is still an underlying pressure for oil traders to reduce stocks of oil and this puts downward pressure on oil prices. So merely looking at oil stocks and seeing levels going down does not necessarily mean that all is peachy keen. That said, since oil prices are now close to the Saudi full marginal cost of production (ie including social costs to keep the King in power), it is unlikely that backwardation will increase unless oil traders see a much worse recession than they predict now. Once the market shifts to Contango then the whole market dynamic is reversed.
OPEC Capacity
A recent IEA report shows that the sustainability of OPEC oil production is about 4 million barrels a day higher than the July production numbers. This means that if they chose to, OPEC could raise production to meet growing world demand. The key variable is if they chose to.
Current Oil Price
Months ago I posted that I predicted the energy price falling from over a 100 a barrel to the all-in marginal cost of Saudi oil production which is somewhere in the mid 80s. We are close to that level now. In a recession, the price may well fall below that levels but just like oil prices have fallen towards that marginal cost, if the price goes below that level there will be pressure for it to go back up. What this means is that now if a good time to buying oil stocks if you are a long term holder. If you are a short term holder then you may want to wait until the recession is in full swing.
So....What am I doing?
I continue to hold an underweight position in oil stocks and will opportunistically buy more on weakness especially in a recession scenario. If the recession takes the SP of oil stocks down to ridiculous levels, then I will overweight and sell the excess once prices recover.
I continue to have a full weight in pipelines and in electricity producers and will likely hold those positions at current weightings.