Bearish Short Term Outlook for Oil Stocks

OPEC Cutting Production

At yesterday's meeting, OPEC ministers agreed to a production cut of 2.2 million barrels per day, which equates to a 4.2 million per day reduction from September levels. In addition, Russia, Syria and other non-member countries are also likely to lower production levels.

The moves are in response to the $100+ drop in oil that has occurred since Jul 11. The global economic slump, and forecasts for reduced consumption next year, has oil producers concerned about a loss of revenues.

Though OPEC members have a long history of violating quotas, production levels should drop after the meeting. The commodities markets, however, are unimpressed as crude was trading at just $43 per barrel this morning.

The Impact on Oil Stocks

For investors, yesterday's meeting won't have any meaningful short-term impact. The "magic" number for many companies is believed to be about $65 per barrel. Oil prices below this level discourage capital investment and production. Prices above this level encourage more activity.

Not a line in the sand, per se, but a good benchmark for gauging what the industry is going to do.

The other issue is the credit markets. Even for companies with strong cash positions, access to debt financing remains difficult and expensive. This also discourages investment.

It is this combination of low oil prices and a lack of financing that has led brokerage analysts to continue lowering 2009 profit forecasts on a large number of oil-related stocks. The downward revisions span most of the energy sector including exploration and production company Anadarko Petroleum Corporation (APC), services provider BJ Services Company (BJS), equipment maker Dril-Quip, Inc. (DRQ) and driller Precision Drilling Trust (PDS).

Even conglomerates like Exxon Mobil Corporation (XOM) are seeing their consensus earnings estimates lowered.

BJS and PDS are Zacks #5 Rank ("strong sell") stocks. APC. DRQ and XOM are Zacks #4 Rank ("sell") stocks.

Crude Will Rebound

Crude prices will not stay at current levels, though the timing of the rebound is uncertain. It will be soon enough, however, to make recent buyers of new SUVs question their purchases. Bluntly put, enjoy the cheap gasoline prices while you can.

Long-term investors should not be in a rush to buy oil stocks, though long-term valuations are cheap. Therefore, it makes sense to continue eyeing the sector, even if the short-term outlook is not positive.

An alternative method is to look at pipeline partnerships. Our senior oil analyst, Sheraz Mian, discussed these in a recent blog post. Among the stocks he likes are Enterprise Products Partners L.P. (EPD), NuStar Energy L.P. (NS), Energy Transfer Partners, L.P. (ETP) and Kinder Morgan Energy Partners LP (KMP).

Though opportunities for short-term capital appreciation might be small, all of these partnerships yield attractive dividends.

Related ETFs

There are several ETFs that target the oil sector, though most specialize in certain segments such as drilling or oil field services. The fund providing the most broad coverage might be Energy Select Sector SPDR (XLE).