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Crude Oil and Energy Sector Reeling from Triple-Punch

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June 28, 2017
Boxing Gloves: Crude Oil Takes a Hit
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One of the most recognized story lines in American culture is that of the once great boxer, now fallen on hard times, desperately looking to make a comeback. The action in the pivotal scene is always the same. Backed against the ropes, he fights to avoid a fall to the canvas and the inevitable ten-count that follows. It wasn’t that long ago that oil was the champ among commodities, but looking at last week’s action, a case could be made that it’s currently on the ropes.

Drillers, Processors Followed Crude Prices Lower

Midweek, the intraday price of crude dipped to a level more than 20% below its 52-week high, officially putting it in a bear market. This continued weakness has had a ripple effect, dragging down some of the more well-known names in the energy sector, as illustrated by their year-to-date performance figures.

Company 12/30/16 Close 6/23/17 CloseYTD Performance
Exxon Mobil (XOM)$90.26$81.61-$8.65    (-9.58%)
Chevron (CVX)$117.70$105.00-$12.70  (-10.79%)
ConocoPhillips (COP)$50.14$44.83-$5.31    (-$10.59%)
Occidental Petroleum (OXY)$71.23$60.12-$11.11  (-15.6%)

But some big names in the oil services sector have been dragged down further year-to-date.

Company
12/30/16 Close
6/23/17 Close
YTD Performance
Baker Hughes (BHI)$64.97$53.99-$10.98  (-16.9%)
Schlumberger (SLB)$83.95$65.93-$18.02  (-21.47%)
Halliburton (HAL)$54.09$41.5-$12.59  (-23.28%)
Diamond Offshore (DO)$17.70$10.34-$7.36    (-41.58%)
Nabors Industries (NBR)$16.40$7.87-$8.53    (-52.01%)
Data source: Morningstar  For illustrative purposes only. Past performance does not guarantee future results.


Last Wednesday was a particularly bad day for crude, when government data showed an increase in oil production, offsetting the recent decline in oil and gas inventories. And a number of analysts chimed in with downgrades on several names across the sector.But some big names in the oil services sector have been dragged down further year-to-date.

The Crude Technical Picture

As highlighted in a recent article, from just before the latest downward move, crude had spent almost a year moving in an ever-narrowing range and was threatening a breakout to the downside of a consolidation pattern, which ended up happening.

Though it was a tough week, crude futures (/CL) prices held at the $42.00 level and bounced slightly on Friday (see figure 1). If this level is breached, some chart watchers see the next support coming in around $39.00, then $35.50, and finally at multi-year lows at the $26.00 level, last touched in February of 2016.

Crude Futures, 3yr

FIGURE 1: CHANNEL BREACH.

The recent down move in crude took prices below a channel that had been tightening for nearly a year. Some chart watchers are eyeing other recent support levels, down to the 2016 low of $26 a barrel. Data source: CME Group. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Of course, there is no guarantee that oil will hit those levels. In fact, if we look at figure 2, the term structure for /CL – which shows price expectations over time – we see that price is slightly higher in deferred month contracts with the December 2018 contract priced at $46.20, roughly 9% above where it’s currently trading.

Crude Oil Term Structure, 2017-2019

FIGURE 2: TERM STRUCTURE OF CRUDE.

Crude futures prices show slightly higher prices in deferred month contracts, with prices in the mid-$40s for contracts out to 2019. Data source: CME Group. Image source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Might History Repeat Itself?  

There is no way to be certain where the price of oil will go, however, one of the unique aspects of commodities is that supply is not fixed, and price can and does drive exploration and production. This phenomenon often makes the oil market somewhat self-limiting.  For example, if the price of crude continues to drop, some analysts expect a massive cutback in the number of drilling rigs in operation, as well as a pullback in production in US shale fields—one of the prime drivers of supply—because it may be less profitable to produce and refine.

Such has been the ebb and flow of crude oil supply. High prices draw in new production, which can lead to oversupply, which tends to drag down prices, which can lead to scaling back in some of the more costly production processes.

And let’s not forget the demand side, which also follows prices, as well as general business conditions. A booming economy tends to boost consumption at both the business and consumer levels.  

But is it Different this Time?

Recent technological breakthroughs have helped drive consumers towards greater adoption of electric cars and ride sharing services. And manufacturers have begun to focus their efforts on renewable energy as well. Are these trends beginning to drive demand down, in a time when, ironically, new technology has also made it easier to find and extract oil?

The effects remain to be seen, but regardless, it’s likely the full transformation away from fossil fuels might take a long time—perhaps even decades—to fully play out. For now, the takeaway for traders and investors is that, after spending nearly a year in a tight channel, crude has broken out to the downside, which some see as bearish, at least in the short term. But cyclical factors and long-term fundamental changes bear watching.

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