The bull market in energy (NYSEARCA:XLE) has lasted for the better part of a decade. Ever since the turn of the new century, energy perma-bulls have made the case that "black gold" (NYSEARCA:USO) should continue its ever-upward price advance thanks to ongoing demand from emerging and developing economies coupled with reduced inventories and areas of supply. We're seeing this thesis challenged right at this moment.
In deciding not to cut crude oil output in the face of oversupply and falling prices, the Organization of the Petroleum Exporting Countries (OPEC), for the lack of a better phrase, is now essentially engaged in a price war with producers in the US that are using breakthrough technology to produce oil in the shale-rich regions of the North Dakota Bakken and West Texas Eagle Ford. The result has been plummeting oil prices, and we fear OPEC will not curb its output until production in the US slows. The problem is that it might not. Two of the fastest-growing independents, Continental Resources (NYSE:CLR) and EOG Resources (NYSE:EOG), require growth to meet targets, and they are not backing down.
OPEC, itself, has little incentive to cut production, as in previous cycles, decisions to curb output have done more to lose share than prop up the price of oil. Instead, OPEC's "new" strategy seems to center on knocking marginal oil producers out of business as incremental projects become uneconomical in a world of lower crude oil prices. The cartel's move could very well mark the end of a multi-year energy bull market…and lower oil prices still. Based on IEA estimates, "most drilling in the Bakken formation, one of the main drivers of shale oil output, returns cash at or below $42 a barrel."
Just as many couldn't imagine crude oil prices under $70 per barrel (as they are today), many may also find it difficult to believe that crude oil prices are on their way to the mid-$40s. But we think they are (in the near term). Our comprehensive outlook for crude oil and natural gas prices calls for $60 per barrel as a probable downside case (see here). We think the volatility of the oil and gas market speaks to the importance of using a range-of-probable outcomes approach. We have very little exposure to the energy sector in our portfolios. As we've stated many a time before, the energy sector is highly volatile, and success is determined by forces outside of constituents' control.
Not only have stocks that are levered to oil taken a beating as a result of the free-fall in prices, but firms tied to the solar (NYSEARCA:TAN) and coal (NYSEARCA:KOL) industries are also in pain. Readers don't have to look too far to uncover that we don't like the investment merits of these industries either. Gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) stocks are falling alongside crude oil prices, too. It is also nothing new for us to say that we're not fans of the investment prospects of gold or silver. In fact, most commodities have had some rough sledding as of late. Even some of the midstream pipeline plays have faced some pressure, even though their performance is tied more to volume than price.
On the other hand, falling crude oil prices will bode well for firms serving more economically-sensitive consumers from the dollar store operators to Wal-Mart (NYSE:WMT) and beyond. The automakers, including Ford (NYSE:F) and General Motors (NYSE:GM), could see higher demand for less fuel-efficient autos, and the airlines and cruise liners could see their bottom lines propped up as a result of lower fuel costs. We see little reason to add an airline or a cruise line operator to our portfolios, however.
We wish we had something more exciting to say, but our portfolios are well-positioned for this "surprising" decline in crude oil prices. Only Chevron (NYSE:CVX), Energy Transfer Partners (NYSE:ETP) and Kinder Morgan (NYSE:KMI) are included in the Dividend Growth portfolio. We do not have any energy sector exposure in the Best Ideas portfolio, and we expect this to be a source of alpha in coming periods. We'll be monitoring future developments in the oil and gas markets closely.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.