The good times might not continue to roll, however. Citigroup's Edward Morse and team call the rally in oil a "head-fake." They explain why:
Published: Feb 10, 2015
By Ben Levisohn
Investors are feeling better about oil and energy stocks--but they might want to reconsider their optimism, according to two recent notes.
Just look at today's market. WTI crude, the U.S. oil benchmark, has gained
The recent rally in crude prices looks more like a head-fake than a sustainable turning point -- The drop in US rig count, continuing cuts in upstream capex, the reading of technical charts, and investor short position-covering sustained the end- January 8.1% jump in Brent and 5.8% jump in WTI into the first week of February...
Short-term market factors are more bearish, pointing to more price pressure for the next couple of months and beyond -- Not only is the market over- supplied, but the consequent inventory build looks likely to continue toward storage tank tops. As on-land storage fills and covers the carry of the monthly spreads at $0.75/bbl, the forward curve has to steepen to accommodate a monthly carry closer to $1.20, putting downward pressure on prompt prices. As floating storage reaches its limits, there should be downward price pressure to shut in production.
The oil market should bottom sometime between the end of Q1 and beginning of Q2 at a significantly lower price level in the $40 range -- after which markets should start to balance, first with an end to inventory builds and later on with a period of sustained inventory draws. It's impossible to call a bottom point, which could, as a result of oversupply and the economics of storage, fall well below $40 a barrel for WTI, perhaps as low as the $20 range for a while.
Deutsche Bank's David Bianco and team call the recent bounce in energy stocks an "exit opportunity." They explain:
Exit opportunity at Energy, unless oil quickly recovers and sustains $70+/bbl
Near and longer-term oil prices are very uncertain. Such uncertainties are best evaluated relative to what stocks price in. We recognize that firms are quickly moving to lower their cost structure, but in order for S&P Energy to now be trading at what we would consider a fair 15x normalized EPS (vs. 20+ 2015E EPS), $70/bbl oil must return and be sustained by 2H15. Future oil prices and corresponding profits are debatable, but the sector's PE on normal EPS is unlikely to exceed 15 given the recent reminder of the industry's commoditized and highly competitive nature. We expect $100-150bn of asset write-downs by Energy in 2015 ($10 of S&P EPS). Write-downs are excluded from non-GAAP EPS, and reduce future depreciation costs to help EPS, but such charges weigh on PEs as they signify the difficulty in earning strong returns through cycles.