Why Low Oil Prices Are Not Sustainable

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Includes: COP, CVX, ESV, KMI, SLB, XLE, XOM
by: Arie Goren

Summary

There have not been any considerable fundamental changes in the oil market from June to December that justify the big drop in oil prices.

OPEC surplus of crude oil production capacity has changed very little between June and December.

Now is an excellent opportunity to make a long-term investment in good energy stocks at a relatively cheap price.

Oil prices have fallen sharply during the last six months. WTI crude oil's last price of $54.73 per barrel is a 45.9% drop from its peak of $101.18 on June 25, while Brent crude oil has declined 46.6% from its peak price of $112.12 per barrel.

WTI crude oil February 2015 leading contract

Chart: TradeStation Group, Inc.

According to the U.S. Department of Energy's recent analysis release on December 18, the principal reasons for the sharp fall in crude oil prices are as follows: lowered expectations for global economic growth, reduced oil demand, and strong production growth. Furthermore, the Organization of the Petroleum Exporting Countries (OPEC) announced after its November meeting that it would maintain a production level of 30 million barrels per day (bbl/d).

However, if we compare the market conditions for December 2014 to those of June 2014, when oil recorded top prices, we can see that there was no significant change, as shown in the table below.

Data: EIA June and December reports

The table clearly shows that there have not been any significant differences between global production and consumption from June to December that justifies such a big drop in oil price. Moreover, OPEC surplus of crude oil production capacity has changed very little. In addition, U.S. commercial inventory has decreased from June, and OECD commercial inventory has risen by only 3%.

I do not see any considerable fundamental changes in the oil market from June to December; global economic growth has not deteriorated, and global oil consumption has even increased since June. As such, in my opinion, other factors such as psychological, political and speculative have been the primary influence on the fall of oil price. Therefore, I believe that the current low oil prices cannot be sustainable over a long period of time.

Energy Companies

Energy stocks have fallen sharply during the last few months as a result of the crash in crude oil price. Since, in my view, the current low oil prices cannot be sustained over a long period of time, I believe that now there are many long-term investment opportunities among energy stocks. The table below shows the top 30 S&P 500 energy stocks according to their TTM operating margin.

Ensco (NYSE:ESV), the offshore contractor of drilling services, has suffered a 45.1% drop in its share price during the last 26 weeks. The company has had a TTM operating margin of 38.3%, and its annual dividend yield is very high at 9.84%. In my opinion, ESV's stock is quite a bargain right now, see my article about ESV.

ConocoPhillips (NYSE:COP), the world's largest independent exploration and production company based on proved reserves and production of liquids and natural gas, is down 18.5% in the last 26 weeks. COP's stock is also very attractive; its TTM Enterprise Value/EBITDA ratio is extremely low at 4.31, one of the lowest among all S&P stocks, see my article about COP.

Schlumberger (NYSE:SLB), the world's leading supplier of technology and services to oil and gas exploration and production industries, has fallen 26.1% during the last 26 weeks. Schlumberger has a very low PEG ratio of 0.93, and, in my opinion, its stock is very attractive right now, see my article about SLB.

An investor, who shares my view that the current low oil prices cannot be sustainable over a long period of time, can also buy an ETF like Energy Select Sector SPDR ETF (NYSEARCA:XLE). The ETF's top holdings are Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Schlumberger, Kinder Morgan (NYSE:KMI) and ConocoPhillips. XLE is down 20.9% in the last 26 weeks.

Conclusion

Since there have not been any considerable fundamental changes in the oil market from June to December, I believe the current low oil prices cannot be sustained over a long period of time. Therefore, in my opinion, now is an excellent opportunity to make a long-term investment in good energy stocks at a relatively cheap price.

Disclosure: The author is long ESV, SDRL, XLE.

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.