What oil stocks could be telling investors

For all of the confusion over Brexit, the Bank of England’s plans for interest rates and the trajectory of the UK economy (which for choice looks to be losing momentum again), one thing does seem clear: the FTSE 100 is doing a very good job of going nowhere fast.

FTSE 100 has gone sideways for 18 months

Source: Thomson Reuters Datastream

Perhaps it is this that prompted one Square Mile shrewdie to opine this week that right now: “There is no value in momentum [stocks] and no momentum in value [stocks].”

The market does seem to be lacking direction, although one trend which catches this column’s eye is a slight revival in the Oil & Gas Producers sector. It still looks like a bit of a dog, down 1.4% this year against the FTSE All-Share’s 5.8% gain, and only ranks 32nd by performance out of the 39 sectors which make up the benchmark index. But its ranking has quietly improved over the past month all the same.

Oil & Gas Producers sector may be showing a little life at last

Source: Thomson Reuters Datastream

But oils are generally seen as “defensive value” stocks so if they really start to outperform this may be Mr Market’s way of telling investors to be a little bit careful. The defensive angle to oil would suggest the market is becoming wary of cyclical plays, perhaps in the view economic and corporate profits growth could be primed to disappoint (again). The value angle would imply someone, somewhere is wary of classic defensives like consumer staples as they simply look expensive for the modest (if supposedly) reliable growth that they offer.

Only time will tell, but this is a trend that may be worth watching as the year draws to a close, given its wider implications, especially as the oil price itself is also struggling to forge any fresh gains of note.

Four indicators

Back in summer, this column looked at four indicators which could help investors to spot turning points in the oil price, which at the time was hovering around $46 a barrel (using Brent crude as a benchmark), just above its year lows. They were:

• US oil inventories
• US and global oil rig activity
• US shale oil output
• The oil futures markets and whether speculators are increasing or decreasing their long or short positions

Now seems a good time to revisit those indicators, to see what, if anything has changed. Oil is now at $55 a barrel (and $50 for the American West Texas Intermediate benchmark) although it is making heavy weather of making a sustained break away from this mark.

Brent crude is struggling to make a real break above the $55-a-barrel mark

Source: Thomson Reuters Datastream

OPEC and non-OPEC members alike seem to be sticking to the production cuts first agreed upon in Vienna in November 2016 and subsequently reaffirmed in May. The limits are due to run until March 2018, although it will be interesting to see what happens at the next OPEC meeting, which is scheduled for 30 November.

Besides reading the runes for that meeting, investors can also turn to our quartet of industry data points. These are all readily available on the internet for no cost.

Reading the dipstick

1. US oil inventories. These figures are published every Wednesday by the US Energy Information Administration.

The good news (for bulls of oil) is that US oil stockpiles (excluding the strategic petroleum reserve) have dropped 12% from a high of 535.5 million barrels to 470 million barrels since March.

US oil stockpiles are still near their all-time high

Source: US Energy Information Administration

The bad is the figure is still flat on a year ago and has increased three times in the last four weeks. Aggregate inventories for raw crude and gasoline are also down just 2% year-on-year so it still looks like America, the world’s biggest economy, is awash with crude. Until these inventories are worked down it could be hard work arguing for a sustainable improvement in crude prices.

2. Oil rig activity. This can be measured via the Baker Hughes rig counts for America and also internationally. The former is released weekly and the latter monthly.

The bad news here (for bulls of oil) is that the count of US rigs in action has jumped 80% year-on-year, while global activity has surged by 42%.

The expansion of US oil and gas drilling activity has begun to slow

Source: www.bakerhughes.com/rig-count

The global active oil rig count is up by more than a 40% relative to last year

Source: www.bakerhughes.com/rig-count

It does seem that as soon as oil pops above $50 a barrel then activity starts again.

The good news however is that the rate of new rigs coming onstream has slowed and the number of working rigs in the USA actually peaked at 958 in late July. Since then the figure has dropped back to 940, while the international count rose by a meagre six to 2,116 in July. Perhaps the cheap, readily-available rigs have all gone. Data from IHS Markit at least suggest that daily rig rates are climbing again, at least for certain types of vessel, and increased costs may deter oil firms from adding further capacity.

3. US shale output. Buoyed by 2016’s recovery in the oil price from below $30 to more than $50, a lot of US shale drillers were able to refinance their debts, issue more paper or even raise fresh equity. They have therefore bounced back with a vengeance.

In June 2016, the number of US active shale rigs was just 274, down 57% year-on-year. As of August 2017 that figure had rebounded to 696.

Bulls of oil will say that number is barely half of the 1,309 peak seen in November 2014.

Bears will retaliate by pointing out how aggregate production of oil from America’s big shale fields (Bakken, Eagle Ford, Haynesville, Marcellus, Niobrara, Permian and Utica) is set to be 5.62 million barrels a day in October, above the prior peak of 5.47 million witnessed in March 2015.

There may be fewer rigs at work but fracking technology is clearly coming along, as the rigs are now so much more productive.

US shale production has already increased by more than 860,000 barrels a day since its autumn 2016 lows, chewing up a big chunk of the 1.8 million-barrel-a-day cut imposed by OPEC and non-OPEC nations.

The good news, such as it is, is that the year-on-year growth rate in output has begun to slow.

US shale oil production reaching new peaks

Source: US Energy Information Administration

4. Futures. Odd as it may sound, oil traders can go a long way to shaping near-term oil movements. This reaffirms how positioning (is everyone bullish or bearish?) and psychology (what will make them change their minds?) can dictate in the short term, even if fundamentals (supply-and-demand for commodities, cash flow and valuation for stocks) will prevail in the long term.

Oil producers and buyers will use oil futures markets to hedge their exposure but traders whose only goal is a financial gain use futures, too. Their net long (bullish) or short (bearish) positions can be tracked.

Buyers have been busily closing out their long futures positions (taken in the view oil would go up) but the number of open contracts is still 695,965 as of 4 October, compared to 190,877 short contracts.

That means the net long (bullish) exposure is 505,088 contracts.

The good news is this is below February’s high of 556,607.

The bad news is this is way above January 2016’s low of 163,504 (reached just before oil bottomed and that probably wasn’t a coincidence).

Oil traders (speculators?) still look very bullish oil, using futures markets as a guide

Source: Thomson Reuters Datastream

In sum, when everyone is already bullish it can be hard for an asset to do well. It may be that the oil market needs to see more buyers turn sellers and the net open futures contracts position shrink further.

Conclusion

For the moment oil stocks are doing well – or at least less badly – even if the oil price is offering them relatively little assistance. This may be indicative of a shift in broader stock market sentiment. Time will tell.

Whether oil gets a wiggle on or not will largely depend on the four factors above, as well as the outcome of the OPEC summit in November. A final wildcard remains geopolitical risk and whether there is an escalation of tensions anywhere in the Middle East in particular.

Russ Mould, AJ Bell Investment Director