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Oil on the Rise: 5 Compelling Arguments Supporting a Bullish Market Outlook into Year End
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Since the pandemic lows, crude oil prices have soared, returning to levels not seen in nine years. The United States Oil Fund ETF ((USO - Free Report) ), a popular proxy for crude oil, has had a breathtaking march higher since reaching panic lows in April 2020. As news of the COVID-19 pandemic spread and worldwide governments responsed with lockdowns, crude oil futures briefly flushed to negative prices. However, as countries began to reopen and pandemic-related stimulus dollars flooded the economy, oil prices rebounded and never looked back. USO shot higher from a low of $16.88 to $70 today. Despite the impressive multi-year move, prices have been stagnant over the last six months, with USO falling nearly 5%.
Image Source: Zacks Investment Research
Several factors have contributed to the rise in prices and the subsequent stagnation. Has the oil sector topped, or is it simply taking a breather? I believe the former. Below are five reasons why the oil industry will thrive over the next year:
Potential M&A Activity: Over the holiday-extended weekend, news broke that Exxon Mobil ((XOM - Free Report) ), the world’s third-largest oil company, was in talks to purchase $49 billion fracking behemoth Pioneer Resources (). While nothing has been confirmed yet, the news is a bullish signal for the industry. The fact that XOM is even contemplating such a large purchase underscores confidence in the company’s financial position. It also shows that the company is willing to bet on the industry’s future.
Growth at a Reasonable Price: Currently, most energy companies are growing their bottom lines at a robust double-digit pace, including industry leaders such as Chevron ((CVX - Free Report) ), Shell ((SHEL - Free Report) ), and British Petroleum ((BP - Free Report) ).
Image Source: Zacks Investment Research
Pictured: BP's EPS has tripled versus pre-pandemic levels.
Despite the rapid growth, valuations remain attractive across the board. So much so that the most famous and successful value investor, Warren Buffett, has been accumulating shares of Occidental Petroleum ((OXY - Free Report) ) hand over fist. Thus, the fact that the oil industry is attractive from both a growth and valuation perspective should put a bid under prices for the foreseeable future – especially since both are hard to come by in the current environment.
Image Source: Zacks Investment Research
Pictured: OXY P/E (~6x) vs. S&P 500 P/E (~19x).
Supply Issues: If you’ve taken (and passed) an Econ 101 class, you know that the balance between supply and demand is at the heart of economics. Last week, OPEC unexpectedly slashed crude oil production by 500,000 barrels per day. While crude oil shot higher in response, it will likely take investors time to adjust to the new constraints. Furthermore, geopolitical issues persist. The war in Ukraine drags on with no end in sight, and instability in the Middle East, such as the civil war in Yemen, continues to disrupt oil production. Any escalations between Taiwan and China would further this phenomenon and boost oil prices ever higher.
Long-Term Technical Picture is Bright: Amateur investors often construe the practice of technical analysis with short-term price movements. While technical analysis can be used in such a manner, a long-term technical view does the best job of smoothing out the big picture and providing the most tranparent picture. Using USO as an oil proxy, the 200-week moving average has been a reliable indicator for investors to monitor when it comes to oil. For example, pre-pandemic in 2020, USO broke below the 200-week moving average at $95 and didn’t bottom until $16. Then, USO broke back above the moving average at ~$30 and didn’t top until $94. In other words, by simply plotting and adhering to this indicator on a chart, investors could have been on the right side of the oil trend over the past three years.
Image Source: Zacks Investment Research
Pictured: 10-year USO chart with 200-week overlay.
Following the OPEC production cut news last week, USO broke back above the 200-week line on massive volume equating to more than double the norm – indicating solid demand.
Image Source: Zacks Investment Research
Finally, there’s an old saying that “From false moves come fast moves.” USO undercut the past six months of price congestion before reversing higher on the OPEC news. As prices flushed below obvious support levels, ill-advised shorts likely piled into the market. Now that prices have regained key support, the “bear trap” may act as even more fuel for oil prices moving forward.
Stuck between a rock and a hard place: The U.S. Strategic Petroleum Reserve is at its lowest levels since 1984. In October, the Department of Energy provided an update via the White House Website, which read, “DOE (Department of Energy) plans to use this authority to enter contracts to repurchase oil for the SPR, targeting a price of about $67 to $72 per barrel or lower…”. When crude oil finally dropped to the “target” area, the DOE did not make the purchase, and OPEC backed the U.S. DOE further into a corner by cutting production levels. If oil is to drop back down in the coming months, the odds favor an outcome where the DOE will try to take advantage – putting an artificial floor below prices.
Bottom Line
Market factors such as supply constraints, geopolitical tensions, and strong price and volume action should act as a confidence booster for prospective oil investors. Furthermore, the historically low levels in the SPR mixed with OPEC’s aggressive supply stance should act as a price floor in the months ahead.
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Oil on the Rise: 5 Compelling Arguments Supporting a Bullish Market Outlook into Year End
Since the pandemic lows, crude oil prices have soared, returning to levels not seen in nine years. The United States Oil Fund ETF ((USO - Free Report) ), a popular proxy for crude oil, has had a breathtaking march higher since reaching panic lows in April 2020. As news of the COVID-19 pandemic spread and worldwide governments responsed with lockdowns, crude oil futures briefly flushed to negative prices. However, as countries began to reopen and pandemic-related stimulus dollars flooded the economy, oil prices rebounded and never looked back. USO shot higher from a low of $16.88 to $70 today. Despite the impressive multi-year move, prices have been stagnant over the last six months, with USO falling nearly 5%.
Image Source: Zacks Investment Research
Several factors have contributed to the rise in prices and the subsequent stagnation. Has the oil sector topped, or is it simply taking a breather? I believe the former. Below are five reasons why the oil industry will thrive over the next year:
Potential M&A Activity: Over the holiday-extended weekend, news broke that Exxon Mobil ((XOM - Free Report) ), the world’s third-largest oil company, was in talks to purchase $49 billion fracking behemoth Pioneer Resources (). While nothing has been confirmed yet, the news is a bullish signal for the industry. The fact that XOM is even contemplating such a large purchase underscores confidence in the company’s financial position. It also shows that the company is willing to bet on the industry’s future.
Growth at a Reasonable Price: Currently, most energy companies are growing their bottom lines at a robust double-digit pace, including industry leaders such as Chevron ((CVX - Free Report) ), Shell ((SHEL - Free Report) ), and British Petroleum ((BP - Free Report) ).
Image Source: Zacks Investment Research
Pictured: BP's EPS has tripled versus pre-pandemic levels.
Despite the rapid growth, valuations remain attractive across the board. So much so that the most famous and successful value investor, Warren Buffett, has been accumulating shares of Occidental Petroleum ((OXY - Free Report) ) hand over fist. Thus, the fact that the oil industry is attractive from both a growth and valuation perspective should put a bid under prices for the foreseeable future – especially since both are hard to come by in the current environment.
Image Source: Zacks Investment Research
Pictured: OXY P/E (~6x) vs. S&P 500 P/E (~19x).
Supply Issues: If you’ve taken (and passed) an Econ 101 class, you know that the balance between supply and demand is at the heart of economics. Last week, OPEC unexpectedly slashed crude oil production by 500,000 barrels per day. While crude oil shot higher in response, it will likely take investors time to adjust to the new constraints. Furthermore, geopolitical issues persist. The war in Ukraine drags on with no end in sight, and instability in the Middle East, such as the civil war in Yemen, continues to disrupt oil production. Any escalations between Taiwan and China would further this phenomenon and boost oil prices ever higher.
Long-Term Technical Picture is Bright: Amateur investors often construe the practice of technical analysis with short-term price movements. While technical analysis can be used in such a manner, a long-term technical view does the best job of smoothing out the big picture and providing the most tranparent picture. Using USO as an oil proxy, the 200-week moving average has been a reliable indicator for investors to monitor when it comes to oil. For example, pre-pandemic in 2020, USO broke below the 200-week moving average at $95 and didn’t bottom until $16. Then, USO broke back above the moving average at ~$30 and didn’t top until $94. In other words, by simply plotting and adhering to this indicator on a chart, investors could have been on the right side of the oil trend over the past three years.
Image Source: Zacks Investment Research
Pictured: 10-year USO chart with 200-week overlay.
Following the OPEC production cut news last week, USO broke back above the 200-week line on massive volume equating to more than double the norm – indicating solid demand.
Image Source: Zacks Investment Research
Finally, there’s an old saying that “From false moves come fast moves.” USO undercut the past six months of price congestion before reversing higher on the OPEC news. As prices flushed below obvious support levels, ill-advised shorts likely piled into the market. Now that prices have regained key support, the “bear trap” may act as even more fuel for oil prices moving forward.
Stuck between a rock and a hard place: The U.S. Strategic Petroleum Reserve is at its lowest levels since 1984. In October, the Department of Energy provided an update via the White House Website, which read, “DOE (Department of Energy) plans to use this authority to enter contracts to repurchase oil for the SPR, targeting a price of about $67 to $72 per barrel or lower…”. When crude oil finally dropped to the “target” area, the DOE did not make the purchase, and OPEC backed the U.S. DOE further into a corner by cutting production levels. If oil is to drop back down in the coming months, the odds favor an outcome where the DOE will try to take advantage – putting an artificial floor below prices.
Bottom Line
Market factors such as supply constraints, geopolitical tensions, and strong price and volume action should act as a confidence booster for prospective oil investors. Furthermore, the historically low levels in the SPR mixed with OPEC’s aggressive supply stance should act as a price floor in the months ahead.