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Only a month ago I started advising investors to soften some shares of the energy sector, after gains of 20% to 30% since the beginning of the year. year. But a brutal May and a weak start to the month of June pushed up oil prices – and some energy companies – in the bear market.
The West Texas Intermediate (WTI) crude oil contract concluded at the beginning of the month ended May with a drop of 16%, which is the first monthly loss of the year. What has happened and is there now a buying opportunity for energy stocks?
Which lowers the price of oil
Two downside factors weigh on oil prices. The first is that it becomes clear that the trade war with China will be long. It is feared that this will affect the demand for oil there.
Add the Trump administration announcement last Friday of its intention to impose a 5% tax on all products imported from Mexico, unless "the crisis of illegal migration is mitigated." These rates could potentially reach 25% by October. This cooled the stock and oil markets, with the WTI losing more than 5% on the day.
World demand for oil has been mixed in recent months. The International Energy Agency (IEA) said that China's oil demand between January and February had risen 410,000 barrels a day (BPD) compared with the previous year. Indian demand increased by 300,000 BPD, followed closely by US demand, with growth of 295,000 BPD.
But oil prices have an impact on demand and have risen sharply since January. This, along with the trade war, could explain more recent news that global oil demand in China is down 0.3 percent from the first quarter.
That brings me to the second factor that I think is affecting the oil markets. Whenever the demand in China slows down, it is safe to say that electric vehicles (EVs) are finally starting to reduce demand for oil.
This explanation raises fears that crude oil will soon end up like coal, helping to lower oil prices lower than they should. Bloomberg recently announced that demand for oil in China will peak in 2025 as a result of electric vehicles. Related: Is it time for a contrarian bet on oil?
So there is a fear premium in that investors do not want to stay with a worthless commodity. I think such fears are premature. In fact, the current low oil prices are totally disconnected from geopolitical factors in Venezuela and Iran.
Investment Outlook
Consider a few points. First, Bloomberg recently said that energy stocks now account for only 5.02% of the S & P 500, which is lower than in early 1999. It should be noted that oil prices had dropped to $ 10 the barrel and that the technological bubble depressed the action. from all other sectors.
As a result, an energy share of 5% today is a significant historical gap. In other words, energy values are again undervalued in relation to history (with the exception of those who think we are now at the end of the oil era).
Second, we should consider the different segments of the energy sector. When oil prices fall, oil producers are usually the hardest hit. Pipeline companies generally experience a less severe shock and refiners often benefit because their margins increase. Related: Torpedo attacks in the Middle East push up oil prices
This is not the case this time. At least not quite. ConocoPhillips and EOG Resources, two of the largest oil producers, recorded declines of 3.8% and 8.2% in May. This is particularly modest given the double-digit drop in the price of oil.
Mid-market companies have held up well. Enterprise Products Partners fell 2.5% in May. Magellan Midstream Partners was one of the few energy companies to have increased during the month (+ 1.1%).
Chevron and ExxonMobil supermajors recorded declines of 2.2% and 8.4% respectively. In this regard, Chevron's return is above 4%, which historically has almost always been a good indicator of purchase.
But the big story is the refiners. The two largest refiners in the country, Marathon Petroleum Corp and Valero, saw their shares fall by 21.6% and 20.2% respectively. Valero's yield climbed to 5.1%.
Refiners often trade with oil prices, but this time, concerns over aggregate demand and the higher price of Mexican oil because of tariffs hit it hard. Mexico's tariffs could be a double-setback if the country takes revenge, as US refiners return large volumes of finished products to Mexico.
Good business in the refining sector
Most segments of the energy sector are relatively more expensive than a month ago, given the sharp drop in the price of oil. If the price stays in the current range for a very long time, oil producers and integrated oil companies will likely experience larger declines.
The midstreams began the undervalued year, but after a sharp rise, many of them had reached fair value. Magellan Midstream was an exception because he had not won as much as many of his peers. The stock was late; May's gain was against the rest of the energy sector.
All things considered, refiners are unlikely to suffer as much as the market feared. In addition, lower oil prices will contribute to higher demand for gasoline, which should help strengthen margins. Refiners are the only sector that seems to have become a bigger market after the drop in oil prices.
By Robert Rapier
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