Following crude’s epic collapse two weeks ago, I noted that Goldman was quick to suggest HY Energy investors “shake off a splash of cold water.”
As the bank patiently explained, “investors are overly focused on US supply data at the expense of strong global data.”
Of course “investors” will be forgiven for this “misguided” myopia. I mean you know, crude stockpiles are at record highs (although last week’s surprise draw means they aren’t at record-er-er highs), production is soaring, and the rig count is at its highest level since September of 2015.
Meanwhile, the Saudis look to have reversed about 1/3 of January’s cuts, although the kingdom did quickly try and play that report off last week after it caused crude to plunge anew.
And besides, it’s not really clear why anybody should be complaining that investors have finally woken up. After all, haven’t we seen enough goddamn willful ignorance for one 13-month period? Look at relative E&P spreads, for God’s sake:
Well on Monday, at virtually the exact same time Reuters, citing “unidentified sources,” said OPEC producers “increasingly favor” extending the supply cut beyond June (which caused a spike that promptly and predictably “mean reverted”)…
…Goldman was back with the “don’t panic” message, only this time from the perspective of equities, not credit.
Once again, the “problem” is that investors just refuse to stop looking at all that bearish data – damn them. Here’s more…
We attribute the correction in oil prices and energy equities in part to concerns over supply-demand stemming partly from greater investor focus on rising US oil inventories/rigs despite overall US oil + product inventory draws in recent weeks, favorable OPEC compliance (for now) and healthy global growth leading indicators. We see a number of key positive catalysts that can serve as an inflection for equity sentiment in the coming months:
(1) Expect US oil inventories shift from build to draw. We expect to see an improvement in US oil inventories over the next two months as we believe current US inventory builds are more seasonal/temporary and will begin to drawdown to reflect the healthy global economy and OPEC production cuts. We note that while many investors have remained focused solely on US crude oil inventory builds (Exhibit 6), the recent decline in total inventories when including product inventories (Exhibit 7) indicates positive underlying inventory data points. We continue to expect refinery maintenance in the coming weeks but believe oil inventories will begin to fall in the next 1-2 months.
(2) Greater comfort with OECD inventories normalizing. While IEA’s recent report indicated a rise in OECD inventories in January with expectations for a modest decline in February, we believe the recent decline in US oil and product inventories (which has been less recognized given the laser focus on US crude inventory builds) combined with global GDP data suggests favorable global oil demand. Floating storage has drawn by ~30 mn barrels, which could have contributed to the rise in US crude inventories but also representing a destocking elsewhere in the world. Additionally, as noted in our commodity colleagues OPEC compliance remains high despite usual data volatility, OPEC appears to be complying with cuts for now, further supporting our expectation for OECD inventory normalization over the next few months.
(3) Signs the natural gas surplus is narrowing. While warm winter weather (Jan/Feb 14%/29% warmer than the 10-year average) has resulted in a selloff for natural gas/natural gas equities, we note that gassy E&Ps typically outperform during spring shoulder months. As seen in Exhibit 14, gassy E&Ps have outperformed the S&P 500 by 15% on average in 7 of the past 10 years during the March – June spring shoulder month period. We believe a correction in gassy E&P equities can benefit all operators and note COG/RRC are our favorite beneficiaries of an inflection in gassy equity sentiment.