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Oil Fundamentals Changing: How to Trade New Environment

Daniel Laboe

Crude oil futures are testing the $60/barrel resistance level, having bounced off of it for the 4th time in the last week of trading. Crude has rallied with stocks since their trough December 24th; S&P 500 up over 16% and crude futures surging over 28%. The jump in oil prices can be partially attributed to the OPEC cartel’s agreement to cut oil production by 1.2 million barrel/day (roughly 4% cut) in the first half of 2019.

Fundamentally oil and equity prices have been inversely correlated, which makes sense logically. As oil prices rise, energy costs for businesses increase. This would, in turn, hurt a company’s bottom line.  In fact, almost every recession since WWII had seen a severe increase in oil prices. This logical correlation has reversed in the last year or 2. Stock prices and oil prices have been rising and falling together.

The fundamental change can be qualified by the rise in US oil production and a stable/declining supply with changing demand causing crude to be relatively elastic. The better companies and the market are doing the more oil the economy will demand, which in turn would raise oil prices in the short-run. Below is a 2-year chart (from Market Watch) showing the relationship between the S&P 500 (black) and crude oil futures (blue). You can see that some positive correlation is evident with crude’s movements being much more pronounced.



The world’s appetite for oil is much larger than anyone would care to consider. Estimated demand for 2019 is about 100 million barrels/day, with OPEC meeting almost a 1/3 of that. The US produces about 10 million barrels/day, significantly ramping up oil production since there slump in 2008 when production was below 4 million barrels/day. Our economy now relies much more on oil production as income with production up almost three times over in a decade. More than 80% of our oil demand being satisfied with US production, the offset of increased oil revenues and increased energy costs is close to a zero-sum game for the US GDP.

Here are a couple of oil stocks to consider as oil prices rise:

BP P.L.C. (BP)

BP has had a great start to this year, outpacing the S&P 500 with 16.5% growth YTD. This performance is due both to favorable economic conditions as well as favorable fundamentals. Upstream oil production has been driving most of the businesses growth in 2018 with fourth-quarter production profits of $3.89 billion up 75% from the previous year of $2.22 billion. BP plans on adding two major upstream projects to their portfolio in 2019. With three key projects already online this year, these cash flow boosters are expected to bring in an additional 900,000 barrel/day of production by 2021. BP looks to be a buy (at the right price) as organic production growth as the centerpiece of the table and rising oil prices the meal. A dividend yield of 5% makes BP even more attractive to the savvy investor. I would look to buy BP on a dip closer to $40, but if you believe in the oil rally momentum you might not want to wait. – Zacks Rank #3 (Hold)


Exxon Mobile (XOM)

Exxon Mobile, the world’s largest publicly traded oil firm, has been able to outperform BP by almost 3% points YTD. The business was able to achieve this through leaner margins and an overall larger asset base which has allowed them to take advantage of the rising oil price. XOM claims a similar story to BP with oil production being the core of revenue growth. They added 4.5 billion barrels of to their reserve increasing it by 23%, ready for any changes in demand. XOM offers a generous 4% dividend yield with a 6.3% increase yearly that they have kept up for the last 35 years. Once again if you believe in the oil rally the world’s largest public oil firm might be the addition your portfolio has been looking for. – Zacks Rank #3 (Hold)


Chevron (CVX)

Chevron is another one of the world’s largest oil and gas companies. This firm is posting a very similar financial story to the previous 2 stocks I discussed with a few key difference. Chevron has been able to achieve the best margins of the three (40% gross margin), and free-cash-flows (FCF) exceeding $3 billion after dividend payouts. This far exceeds that of XOM and BP who both posted negative FCF for 2018. This sizable FCF should give CVX the proper flexibility to maneuver themselves into profitable investment opportunities. Tracing this stock back down to the $100-$110 range would be a preferable buy point considering the stock is trading just south of its all-time high. – Zacks Rank #3 (Hold)

Returns for CVX, BP, XOM over the past 52 weeks:



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