One of the key drivers of the market since summer along with one of the primary topics of conversation for financial pundits far and wide has been the breathtaking plunge in crude. Prices for West Texas Intermediate (WTI) have moved from just under $110 a barrel in early summer to below $50 a barrel as I pen this article.
Do you recall the name of any “expert” prognosticator who made this call a year ago?
The huge plunge in the oil markets came from off the radar and few if any “experts” saw this development happening especially outside a global recession. However, it has not kept these same prognosticators from trying to call a bottom. $75 a barrel was a popular floor for a while before oil took those levels out and even $55 a barrel got several calls.
So what is my prediction for where crude will ultimately bottom?
Simply put I don't have one as I believe with all the myriad factors in play it is folly to try to predict one. This commodity market is notoriously fickle. The world consumes roughly 90 million barrels a day, of which some 20 million barrels a day is used by the United States.
What is unique about this market is an oversupply of just one to two million barrels a day can cause prices to plunge like they are now. If demand exceeds supply by the same amount we can see crude prices surge as they did just before the financial crisis touching $147 a barrel in the summer of 2008.
There are so many factors that go into the price of crude as dozens of countries produce black gold and hundreds consume it. One of the main drivers of this recent sell-off are the actions of the main swing trader in the market, Saudi Arabia. The House of Saud has consistently lowered the price on the some 10 million barrels a day the kingdom produces in order to maintain “market share”.
No one much believes this is the real reason Saudi Arabia is not ramping down production to maintain high price levels like it has in the past. Some have speculated the kingdom is trying to put u.s. shale producers out of business. Others have said their motives are to bankrupt Iran and/or provide leverage to the current negotiations going on to cease their nuclear programs or to enforce discipline within OPEC. I have also seen some speculation saying this is a coordinated effort with the United States to punish Russia for its transgressions in Crimea and Ukraine, something I do not put any stock into at this time.
The truth is no one knows the real motives behind the moves Saudi Arabia has made in recent months. Obviously there other factors in play as well such as surging production in the United States and Iraq and the return of Libya to the markets recently.
There are two types of causes that can hammer the oil markets. One is when demand dries up such as when crude plunged to $34 a barrel in early 2009 as the world sank into a global recession. The other cause is triggered by a surge in supply like that from the North Sea in the 1980s. The recent plunge in the price of oil has been caused by a surge in supply as global demand has remained fairly stable, although subdued world economic growth is somewhat of a headwind right now.
The point is that there are too many diverse crosscurrents to predict where the oil market is going in the foreseeable. Two years from now oil could just as easily be $35 a barrel as $100 a barrel. Investors should remember that oil sold off to $10 a barrel both in 1986 and 1998.
Ironically and completely coincidentally these two last supply driven sell-offs each occurred at the low point in a two term presidencies on an approval basis and helped Ronald Reagan survive Iran-Contra and Bill Clinton come out of an impeachment crisis with his ratings intact. From a historical perspective I find it most interesting that low gasoline prices are again arriving with the current two term resident of the White House facing a similarly low point in his presidency after a second mid-term election debacle for his party.
Obviously the plunge in crude has decimated a good portion of the energy sector over the last six months. This is especially true in the small and mid-cap exploration and production area, particularly those drilling concerns with a good amount of debt. On the flipside, retailers and restaurant stocks have gotten a major lift. In addition, transports have soared.
My call to buy airlines like Delta (NYSE: DAL) and American Airlines (NYSE: AAL) on the media driven Ebola declines back in October might have been one of my best calls of 2014.
I have been doing some bottom fishing here with the mid-major exploration and production space with firms such as Devon Energy (NYSE: DVN) and Chesapeake Energy (NYSE: CHK). These companies have the financial flexibility to pick up new acreage on the cheap as smaller concerns are forced to get rid of assets in “fire sales” after being driven into survival modes. Both of these plays should also remain profitable even with energy prices at these bargain basement levels.
I am doing this on a very incremental basis as no one has a good and reliable forecast on where and when crude will ultimately bottom. More critically, I am picking up shares in stocks that have been unfairly punished on the pull back in crude. Topping that list is railcar maker Greenbrier Companies (NYSE: GBX) which just reported stellar quarterly results. The shares are up just less than 20% since their inclusion in the December report of The Turnaround Stock Report but are still down some 30% from recent highs. Click here to read my deep dive from The Turnaround Stock Report on this undervalued manufacturer I am now making available for free as it is one of the cheapest stocks I currently cover and should be a strong performer in 2015 regardless of which oil prices ultimately go in the New Year.
