Oil Price Slide Creates Opportunities

The 30% drop in oil prices from the 2018 peak has coincided with a period of weakness for broader equity markets, leaving many oil firms undervalued

Jeffrey Stafford, CFA 9 January, 2019 | 9:46AM
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Oil prices

After outperforming the broader market for most of 2018, the Morningstar Global Energy Index dropped 22% in the fourth quarter, owing to the steep drop in oil prices that began in October.

The more than 30% drop in oil prices from the 2018 peak has coincided with a period of weakness for broader equity markets, making energy stocks look much more attractive than they did when OPEC met in June.

After touching $75 per barrel in early October, West Texas Intermediate crude plummeted below our medium-term price of $55 per barrel. Recent cuts to Saudi Arabian output has spurred a small recovery in crude prices in early January, with WTI moving back to around $50. Roughly 8% of Morningstar’s energy coverage trades in five-star territory, which means they are significantly undervalued.

OPEC and its partners announced on December 7 a deal to cut crude production by 1.2 million barrels per day beginning in 2019. OPEC will account for 800,000 bpd of the cut, with its partners, led by Russia, responsible for the remaining 400,000. After briefly resuming oil production in the second half of this year, OPEC will cut output again, as oil prices have declined greatly from October highs.

Oil prices

We said in June that a shale-induced supply surge would be the likely catalyst to sink oil prices toward our medium-term price of $55. This has largely played out, with US production up 7.5% from June to September and more than 14% since the end of 2017. Other factors have contributed to the oil price decline since the last OPEC meeting, including higher-than-expected Iran production and demand worries as prices rose.

Given our bearish long-term oil outlook – we're still 15% below the long-term consensus forecast – we think investors are more likely to find value in the volume-driven areas of the sector, namely midstream – transport, storage and distribution of oil – and downstream, or refining. Nonetheless, the recent sell-off has created buying opportunities for multiple integrated firms, exploration and production companies, and services firms, too.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Jeffrey Stafford, CFA  Jeffrey Stafford, CFA, is an equity analyst for Morningstar, covering agriculture and chemical companies.

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