"Ladies and gentlemen, if I say I'm an oil man, you will agree. Now, you have a great chance here, but bear in mind, you can lose it all if you're not careful."
Daniel Plainview, There Will Be Blood (2007)
The stark 2007 film "There Will Be Blood" featured one of my all-time favorite actors, Daniel Day-Lewis, as a self-proclaimed "oil man" who comes to Little Boston, California to capitalize on the town's newly discovered oil reserves. As the movie's ominous title implies, the plan doesn't go exactly as expected, and the movie eventually culminates with a dark, bloody scene in a bowling alley (parental supervision strongly advised!)
Lately, the fate of oil bulls has been similarly dark. Plenty of bullish blood has already been spilled in the oil market, and with today's drop to a new year-to-date low in West Texas Intermediate (WTI) crude, the outlook looks likely to get worse before it gets any better.
The proximate fundamental cause for this week's drop has been news that Libya is pumping the most crude oil in four years after a deal with Wintershall AG enabled at least two fields to resume production. In addition, the amount of oil stored in offshore tankers reached its highest level of the year at 112M barrels. As any economics 101 student will tell you, a large increase in supply will inevitably push down price, cetis paribus.
Six weeks ago, we took a deep dive into the absolute and relative performance of the S&P 500's energy sector (see "Sector Showcase: XLE bears have all the energy"). At that point, we concluded that, "[w]ith this year's breakdown from the 2016's "bearish flag" pattern, the long-term underperformance of energy stocks could carry over through 2017 and beyond." Updating the relative performance chart from that early May piece suggests that, if anything, the outlook for energy stocks has worsened with the latest drop in oil prices:
As we noted then, the top holdings in XLE include Exxon Mobile (XOM), Chevron (CVX), Schlumberger (SLB), ConocoPhillips (COP), Occidental Petroleum (OXY), and Kinder Morgan Inc (KMI), all of which are in our universe and are in clear downtrends. We continue to monitor for low-risk opportunities to short these names in line with the longer-term bearish trend.
Of course, the outlook for the energy sector, and every sector, is constantly evolving and if the evidence changes, we'll change our outlook. For now though, path of least resistance for energy stocks remains to the downside. As Daniel Day-Lewis reminded us above, XLE bulls "can lose it all if [they're] not careful."
This research is for informational purposes and should not be construed as personal advice. Trading any financial market involves risk. Trading on leverage involves risk of losses greater than deposits.