The crude oil market turned sharply higher last week. In case you missed it, the big news was that OPEC finally delivered on months of talk and delivered a deal for a worldwide cut in oil production.
The January NYMEX crude oil futures contract soared from a low at $44.82 a barrel on Nov. 29 into Monday's high at $51.04 per barrel.
The OPEC deal aims to trim 2% of global oil production, with OPEC cuts totaling 1.2 million barrels per day. Russia is playing ball as well. After the OPEC meeting, Russia's energy minister, Alexander Novak said the nation would, conditional on its technical abilities, cut up to 300,000 barrels per day, according to a Bloomberg report.
The question for investors is – will this matter?
"People forget the progress the U.S. has made in producing its own oil. We are not nearly as reliant on OPEC as we used to be," says JJ Kinahan, chief market strategist at TD Ameritrade.
U.S. domestic crude oil production has indeed skyrocketed from around 5.1 million barrels a day in 2006 to 9.4 million in 2015, according to the U.S. Energy Information Administration. "OPEC doesn't have the complete sway it has on the market as it once did," Kinahan says.
Others agree. “Oil markets have bid up oil prices in a fury believing the agreement, which comes into force in January, is exactly what's needed to balance supply and demand. I believe this rally represents a balloon that's filled with too much air and risks a correction -popping the balloon- that may be seen in due time," said Patrick DeHaan, senior petroleum analyst for GasBuddy.
Will The Rally Stick?
January crude futures broke the sound barrier that is the $50 per barrel level in early action Monday. However, throughout 2016, crude oil has had a difficult time holding above the $50 level, Kinahan notes. In fact, the oil market has tested the $50 level several times on the daily chart – first in June, again in August, and then again in October. "It still has to prove that it can hold above $50 for an extended time," Kinahan says.
TD Ameritrade clients can gain a longer-term perspective outlook on the crude oil market by viewing a weekly chart. See Figure 1 below. From a technical perspective, a large inverted head and shoulder bottom formation could be developing on the weekly chart. This is a potential bottom formation, but sustained gains above the so-called "neckline" trendline would be needed to confirm this chart pattern.
Who Benefits From The Rise in Crude Oil Prices?
There are three main kinds of energy companies and it is the upstream companies, or those closest to the well that benefits the most from higher oil prices, says Sam Stovall, chief investment strategist at CFRA. That includes the oil and gas drilling companies, exploration and production and oil services companies, he says.
Here's a quick primer on the different energy streams:
- Upstream: The companies that find oil, drill for oil, and extract it
- Midstream: The companies that process, store, and transport oil (to the downstream)
- Downstream: The companies that refine crude oil into end products (gasoline, diesel, and jet fuel), market those products, and sell them (gas stations, for example)
Then there are the so-called "supermajors," which include integrated oil and gas companies that tackle it all: the upstream, midstream, and downstream segments of the oil and gas market.
Playing the Energy Move
Not all traders are equipped or want to trade crude oil futures, notes Kinahan. Furthermore, with its unique risks and complexities, futures trading is definitely not for everyone. However, there is an opportunity to trade opinions in the crude oil market "synthetically," he says. He points to companies like Exxon Mobil and Chevron "which will be very much affected by the price of crude oil" as stocks to study.
Kinahan warns that these companies that have been favored by the dividend yield crowd have been hurt amid the expectations for a Fed rate hike on December 14. "They could be stuck in the mud between the two forces of a Fed rate hike, which is negative and rising crude oil, which is positive," Kinahan says.
TD Ameritrade clients can monitor different timeframe charts of crude oil through the thinkorswim® platform. Short-term traders can monitor TICK charts for momentum clues, Kinahan says. See Figure 2 below.
The Big Picture?
What about the overall market? Stovall notes that an upward climb in oil prices is actually beneficial to the stock market as a whole. "CFRA has found a 93% correlation between the price of oil and the S&P 500 energy sector earning. As oil prices go up, so do the earnings of the energy sector," Stovall says.
"Energy was a big drag – an influential headwind in 2015 and 2016. Now, it will be a supportive tailwind in 2017 to the S&P 500 earnings outlook," Stovall says.