Oil and energy ETFs have been on a rough ride since early 2014. A global growth slowdown and rising U.S. shale output have taken the space into a tailspin. Stringent efforts by the OPEC and some non-OPEC countries to cut this output have definitely offered some occasional relief to the oil patch but there’s no concrete solution in sight yet. Notably, despite OPEC’s repeated efforts, crude failed to hold up well in the recent past (read: Is Fresh OPEC+ Output Cut Enough to Boost Oil & Energy ETFs?).
Oil prices had sunk below $30 in early 2016 and are now around $55/ barrel. Along with research houses like Goldman Sachs, we do not see any material recovery for oil prices next year as well. The U.S. investment bank stated that Brent crude futures are caught in a tug of war between “worsening growth expectations and rising Middle East tensions” of late, per CNBC. While the drop in expectations is concerning, rising Middle-East tensions have offered relief sporadically (read: Oil ETFs in Focus Amid Trade War Blows & Rising US Supply).
Subdued Earnings in the Cards
A bunch of big energy names are likely to report third-quarter earnings this week, and the “results are expected to be worse than the same period in 2018.” For the quarter, oil/energy companies are likely to report a 34.8% slump (maximum decline among 16 Zacks classified S&P 500 sectors) in earnings on a 4.8% revenue decline.
So far, 10.3% companies have released their quarterly numbers, of which reported a 12.1% decline in earnings and a 4.9% dip in revenues. There was a blended beat ratio of just 33.3%, per Zacks Earnings Trends issued on Oct 23.
Some of the largest banks financing the U.S. oil and gas drillers recently lowered their expectations for oil and natural gas prices. The companies have reduced the value of oil and gas companies’ reserves.
“The value of reserves estimated by banks serves as the basis for many small oil and gas firms to get funding for their drilling activity and operations. And in recent months, in many cases, this is the only source of funding that many of them can get because the equity and bond markets are practically closed for small oil and gas firms right now,” per oilprice.com. Not to mention, such lowered value of reserves will result in more limited access to the capital markets.
Concerns Over Demand Growth
Sluggish global growth is a crisis in the space. The IMF slashed its global growth projections lately, calling for 3% (a decade-low) and 3.4% expansion in 2019 and 2020, respectively. Projections were cut from the previous levels of 3.2% and 3.5% recorded this July. Notably, the forecast for this year marks the lowest growth rate since 2009.
The Atlanta Fed’s GDPNow model estimates that the U.S. economy expanded 1.8% in the third quarter, down from its 2% growth in the second quarter. Goldman Sachs also trimmed its outlook for Q3 GDP in recent times and quoted the projected figure at 1.7% (read: S&P 500 ETFs & Stocks to Buy on a Likely Great Rotation).
This suggests a lower demand for oil too. Goldman Sachs tempered its oil demand growth forecast to 950,000 barrels per day (b/d) in 2019, down from the previous estimate of 1.25 million b/d. It also cut its forecast for demand growth in 2020 to 1.25 million b/d, down from 1.45 million b/d.
Massive Stock Market Underperformance
Constant underperformance has led investors to lose faith in oil stocks that have been the worst performers in the S&P 500 this year. Investors should note that the Invesco S&P SmallCap Energy ETF (PSCE - Free Report) has tanked about 81.2% in the past five years, 62.5% in the past three years, recorded a 50% loss in the past year, and a respective of 23.6% and 4.8% losses year to date and quarter to date.
Other energy ETFs —SPDR S&P Oil & Gas Equipment & Services ETF (XES - Free Report) , SPDR S&P Oil & Gas Exploration & Production ETF (XOP - Free Report) , VanEck Vectors Oil Services ETF (OIH - Free Report) and Invesco Dynamic Oil & Gas Services ETF (PXJ - Free Report) — have also underperformed consistently in the last five-year, three-year, one-year and year-to-date period. Five-year losses were in the range of 60% to 78%, while year-to-date losses have been around 15-20%.
Investors should note that most of the energy ETFs carry a Zacks Rank #4 (Sell) or #5 (Strong Sell). The above-mentioned analysis explains the ranks and the reasons why energy ETFs are frightening enough this Halloween.
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