I have been "in the field" for the past several days and will be back in circulation later this week. But I wanted to send you a note on what's been taking place recently.
The last two trading sessions have seen a spike in oil stocks. The rise has been focused on companies that provide services to early-stage field development, as well as for crude production.
Now, we have witnessed a similar "summer pop" in each of the past three years. It tends to signal a rise in expected medium-term demand for both crude oil and oil products.
However this time around, the improvement isn't reflected in companies across the board, but rather in those emphasizing geographically specific field plays.
This time, the early stage of the summer rally is focused on U.S., rather than global, production.
And this wrinkle may be especially significant for energy sector investors.
An initial improvement in oil field service (OFS) stocks - companies that cover everything from initial geological prospecting, through seismic study, site preparation, to well drilling and completion - is normally associated with such a spike.
Usually, those OFS providers that have the largest global impact experience the surge first.Â Â
Well, it appears the current upward move is structured a bit differently. While the major OFS players - Schlumberger (NYSE: SLB), Halliburton (NYSE: HAL), and Weatherford International (NYSE: WFT) - are each up 2.5 to 5.5% over the past 2-3 sessions, the real improvement is coming elsewhere.
Primary beneficiaries currently are a range of stocks that have a direct bearing on the more immediate availability of crude oil to refineries. These include pipeline and related midstream service areas, storage facilities, operators with immediate in situ reserves that can be brought on line quickly, and small or medium-sized producers having multi-year success in emphasizing basins in the American West and Southwest.
Two Takeaways for Oil Stocks
There are two important dimensions to what has taken place over the past several days. First, this is a rather clear indication that the demand curve is rising. The extent of that rise will determine the degree to which the spike moves further upstream. That is, the wider the base for demand increases, the more price improvement there will be in the OFS sector.
For now, this is a short-term development. As a result, the improvement comes primarily from those companies benefiting from direct access to the raw material supply chain. One of the ways we will know whether there are stronger legs to the rally is to see how it affects refinery shares.
These appear to be stabilizing, but the jury is still out on how much (or how quickly) oil product demand will fall into line. I expect a decline in gasoline and distillate (primarily diesel during this period of the year) inventories to develop. That in the absence of concerted data on demand pressures (always taking longer to develop) should improve the refinery sector (once again short-term, pending a genuine market push).Â
Second, it may be premature to say anything significant about the overall impact. But this may be shaping up to be the first indication of what many pundits have been taking about for awhile.
As I've noted on several occasions in Money Morning, much of the ballyhoo surrounding American tight (shale) oil's effect on supply price has been very overdone.
For one thing, the price points justifying full development of many basins remain unknown. Much of this volume will end up being more expensive to lift and process than conventional production.
For another, significant exploitation requires additional capital investment that may be difficult to obtain under current market conditions. And infrastructure (especially for throughput) will remain limited until pipeline networks, gathering systems, initial processing, and storage capacities are improved. That also translates into multi-billion dollar investment requirements.
What's happening thus far is more limited. The advantage is directed to crude available for quick transit, using wells with easily accessible reserves, and employing existing midstream facilities with excess capacity availability.
Absent a breakout in demand, we may have a limited pop on our hands here. I don't expect the near-term price of crude to increase much above $100 a barrel in New York (West Texas Intermediate, or WTI, benchmark grade). And absent an unanticipated market shortage or geopolitical event, Brent in London will probably not reach $115. The spread between the two resulting in a 10-15% premium for Brent will also benefit U.S. prices.
The investment advantage here isn't the result of a surge in the price of crude futures. It's coming from focused positioning of oil that's already available.
This may be a short spike. On the other hand, it could be establishing a floor for some later moves up that could be wider in sector impact.
Either way, it's a welcome development.
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