Following the 17-month bear market that ended in March 2009, one of the longest-running bull markets in U.S. history began. The current bull market is the second longest streak on record without a 20% drop in the S&P 500.
But the performance across the S&P 500 sectors has been uneven. When oil prices collapsed in the second half of 2014, the energy markets entered a bear market even as the broader markets continued to prosper.
Although the energy sector rebounded in 2016, the fundamental reasons that led to the energy bear market hadn’t changed substantially. The global oil market remained oversupplied. So, the gains in 2016 were mostly given back in the first half of 2017.
But the International Energy Agency’s (IEA) most recent Oil Market Report gives some reasons to believe that the bear market in the energy sector may finally be coming to an end.
The report notes that global oil demand grew by 2.3 million barrels per day (BPD) year-over-year (YOY) in Q2, which was a stronger-than-expected pace. The IEA revised the 2017 growth estimate for 2017 upward to 1.6 million BPD. Demand growth has been unexpectedly high in Europe and the U.S., driven by low oil prices.
Yet crude oil demand grew strongly throughout the current energy bear market, so that alone isn’t enough to signal that better times are ahead for the energy sector. Where things get interesting is in the global supply picture.
In August, oil production fell in both OPEC and non-OPEC countries. Global oil supplies in August dropped by 720,000 BPD, with most of the decline coming from non-OPEC countries. OPEC also experienced a production decline for the first time in five months, as supply fell by 210,000 BPD.
Strong demand growth and declining supplies are finally having the desired impact on high global crude oil inventories — which have been the single biggest factor behind the bear market in the energy sector. The huge surplus has been falling steadily for months and is on a trajectory to soon reach the five-year average inventory level.
The IEA notes that “OECD product stocks were only 35 million barrels above the five-year average at end-July and could soon fall below it because of the impact of Hurricane Harvey.”
On that same theme, a recent story from Bloomberg reported:
“Oil traders are emptying one of the world’s largest crude storage facilities, located near the southernmost tip of Africa, as the physical market tightens amid booming demand and OPEC production cuts.”
The energy sector has already begun to respond to the shift in the fundamentals, as the price of West Texas Intermediate has moved back above $50 a barrel. Energy stocks have begun a broad-based rally as well.
Since mid-August, the Energy Select Sector SPDR ETF, which contains the largest energy companies in the S&P 500, has risen 10%. The S&P Oil & Gas Exploration & Production SPDR ETF, a better representative of the small-cap drillers, has rallied 16.2%.
For the first time since mid-2014, both the energy market fundamentals and sentiment are improving in earnest. As a result, this may mark the true end of the energy bear market, in contrast to what turned out to be a false start in 2016.
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Excellent commentary.
I think oil can always go higher, but I sense that each iteration will be shorter going forward.
Lots of politics in the picture. As always, so much of oil production is locked up not by geology, but man. Venezuela, Mexico, Iraq, Iran, Libya, Russia—there is gobs of oil out there. Saudi Arabia has vast heavy oil deposits they have never even bothered with.
But alternatives to oil are getting better daily, from batteries, to fuel-cell cars, to CNG and LPG.
With some luck, I think the future is cleaner and more prosperous. It certainly should be.
1. OPEC has been successful in raising prices from 40s to 50s (about $10). Absent a major disruption think it will be hard for price to move over 60 Brent (55 WTI) because US shale growth starts kicking in strong. It is very sensitive in the vicinity of $50 prices. Conversely, prices are unlikely to drop below 40 unless there is a major fracturing of the cartel. (FWIW, I think the Saudis have more oil, not less. They, along with Iran/Iraq, etc. could develop their fields much more if it was a free market just responding to demand.)
2. (nit) Don’t like terming markets as “bear” or “bull”. Puts too much emphasis on slope of the curve rather than level of the price. Often confounded with a momentum investing economic fallacy.
3. Good discussion of oil microeconomics. Really prescient in terms of how OPEC acted after OCT16.
https://www.youtube.com/watch?v=G_BpEqZ15zQ (31:45 to 52) Main point is that Saudis were just trying to make sure they were not the only one cutting and that they cut from a high level. They remember the 1980s.