Oil Is In A Bull Market

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Includes: OIL, USO
by: Marvin Clark

Summary

Oil has staged a tremendous rally off of last Wednesday’s low of $26.19, climbing to $32.10 a barrel -- that’s a 21% gain.

Since the beginning of 2015, 42 oil companies have gone bankrupt.

Since the beginning of December, the price of oil has mirrored the S&P 500.

Oil's in a bull market. I know that sounds crazy, but check out the numbers. West Texas Intermediate crude oil is back above $32 a barrel after a gain of more than 8%. Oil has staged a tremendous rally off of last Wednesday's low of $26.19, climbing to $32.10 a barrel today -- a 21% gain. The definition of a bull market is a 20% gain.

It certainly doesn't feel like a bull market, and typically it takes more than three sessions to establish a bull market. And while it's possible that last Wednesday marked the low price for oil, the rally feels more like speculators have jumped in, trying to time a low or covering short positions.

The rally has been too fast for the oil companies to catch up with the commodity. More than 99% of 559 oil and gas companies are in a bear market. Furthermore, one-third of those companies have fallen over 90% from their highs, which is an indicator of potential bankruptcy issues.

Early last week, the American Petroleum Institute and the Energy Information Administration both reported that inventories of crude oil increased by more than 4 million barrels over the past week. It seems counterintuitive -- more supply, no increase in demand, and the price moved higher this past week. The problem is that many of the U.S. oil producers are adding supply even though they aren't making money.

Oil drilling is a capital-intensive business. Many of the newer producers issued debt to fund operations, and now they are forced to keep pumping, even at a loss, in order to service the debt. Standard & Poor's estimates that 50% of energy junk bonds are "distressed," meaning they are at risk of default. Unless prices change soon, many are just postponing the inevitable.

Since the beginning of 2015, 42 oil companies have gone bankrupt. The ones that haven't are feeling enough financial stress to slash spending and cut tens of thousands of jobs. And if we start seeing even more defaults, that will impact the banks.

In the past week, we saw earnings reports from the big banks. Wells Fargo (NYSE:WFC) lost $90 million from its portfolio of oil and gas. JPMorgan Chase (NYSE:JPM) nearly doubled its loss provisions in the fourth quarter (an extra $124 million) mostly due to bad energy loans, with a warning that reserves might need to be increased to $750 million.

Citigroup (NYSE:C) set aside reserves of $300 million for bad energy loans, and they are bracing for losses up to $600 million in the first half of 2016. If prices hold around $25 a barrel, they reckon they will need to set aside $1.2 billion.

It doesn't seem far-fetched that banks might want to prop up oil prices. Or, as JPMorgan CEO Jamie Dimon recently said, "To the extent we can responsibly support clients, we're going to. And if we lose a little bit more money because of it, so be it."

Now, here's where it gets interesting for you. Since the beginning of December, the price of oil has mirrored the S&P 500. When oil goes down, the S&P 500 index drops; when oil goes up, stocks move higher in lockstep. This is not the norm. Typically, there is an inverse relationship: When oil goes higher, stocks tend to fall because businesses face higher energy costs, which cut into the bottom line; when oil drops, businesses get a break on margins.

In the past, higher oil has acted as a drag on the economy. Look at any recession over the past 60 years and it was preceded by, or coincided with, higher oil prices. So what we are seeing now, with oil and stocks moving in lockstep, is an anomaly. Now, here is a further disconnect: Demand for oil is still growing. Yes, it has slowed, but it is still growing. One of the things the market is really good at is reversion to the mean.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.