Summary
Long overdue fundamental factors should begin to come into play after the Sept 23 crude oil inventory report. The energy sector's y-o-y earnings comps in 2009 are going to be ugly and energy investors can not extrapolate forward earnings in 2010, expecting crude oil prices to average $75 to $100 in 2010. While the energy sector has been an outperformer.
The energy sector has underperformed the broad market in 2009, the recent relative outperformance in recent weeks is apt to diminish after Q3 09 earnings are reported in October 2009.
Analysis
Today's crude oil inventory report featured the following dismal news for future crude oil prices in both the near and intermediate term:
Crude oil inventories rose by 2.8 mil barrels for the week ending September 18, in stark contrast to the consensus expectation of a 1.4 mil barrel decline. Gasoline inventories ballooned by 5.4 mil barrels, distillate inventories rose strongly by 3 mil barrels. Refinery capacity utilization fell from 86.9% to 85.6%.
Crude inventories are 15.7% above their levels of a year ago. Gasoline inventories are 19.2% above year-ago levels. Distillate inventories are a massive 36.1% above year-ago levels. Distillate demand fell further from an already depressed level. The amount of distillates consumed still rests well below the amount produced. (so much for the green shoots recovery story).
Refineries are producing more product than being demanded, as evidenced by bloated gasoline and distillate stockpiles. Even though refineries are operating at very low levels of capacity utilization, they must further reduce production or else petroleum product inventories will continue to swell.
How serious are OPEC member countries taking their production quotas in light of the recent rise in crude oil prices? OPEC is notorious for not adhering to previously announced production cuts. Though they have idled 4 million barrels a day or one-third of their daily production capacity, worldwide global demand is still receding faster than their production cuts to date. Excess production at elevated crude oil prices has resulted in more than 60 million barrels of oil being presently stored on offshore super tankers.
So I ask, if the green shoots recovery is so spending, how come the govt’s fiscal spending hasn't been able to fill the void in energy demand from the private sector? It makes the whole green shoots recovery story strangely suspect. Be careful what MSM spoon feeds the public for mass consumption.
Crude oil prices fell more than 4% today in response to today's weekly crude oil inventory report. Given the foregoing and what we know from yesterday’s report, the fundamentals just suck for crude oil. A round trip to the Q3 lower extremes around $50 would not surprise in the least. This is also half way back to last years lows. Half way back to last year's lows represents a mean reversion, but we all know markets overshoot both on the upside and downside. So, seeing prices below $50 in the coming months should be of no surprise to anyone if global demand for energy does not recovery in 2010.
Here is the deal, crude oil demand in developed countries is conspicuously absent. No one is expecting the private sector demand to pick up measurably in 2010 as banks continue to curtail their lending activities, reducing investment demand from the private sector.
China’s crude oil demand curve may still be positively sloped as well as other emerging economies, but that demand curve is not going to make up for the massive demand destruction in developed countries. For the energy sector, if crude oil prices return to roughly $50 in subsequent quarters, it does not bode well for annual earnings growth in 2009-2010 for the energy sector.
The back of the napkin estimate of the average price of crude oil in 2009 is going to flush out somewhere in the $50s. But the average price of crude oil was approximately $102 in 2008 (a rough estimate based on monthly closing prices).
Energy investors are looking at a contraction in energy companies earnings growth rates in 2009. Oh, investors might take heart and look over the earnings recession valley in 2009 if they could extrapolate forward how good they expect 2010 earnings will be y-o-y when compared to 2009 earnings.
Yes, based on the average price of crude oil in the $50’s for all of 2009, all crude oil prices need to do in 2010 is start climbing above $75. No doubt, bullish investors will be leaning on GS and other analysts’ recent price targets for crude oil to be $85-$100. No, given the foregoing fundamentals, extrapolating forward prices for crude oil to be $75 and higher could be delusional thinking without evidence of a recovery in worldwide demand in crude oil products. Not now, but a rebalance to underweighting energy stocks should be given some consideration after Q3 earnings come out for the energy sector. I expect quite a bit of profit taking on these announcements and thereafter see sector underperformance without evidence of a demand recovery.
This author consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
