- Oil and oil stock volatility surged yesterday following a false report OPEC may seek to increase production at its next meeting.
- Thanksgiving week is notoriously tricky for oil traders.
- Oil prices tend to rebound in December, but seasonality could be trumped this year by recessionary worries.
Everybody was taken off guard when the Wall Street Journal reported yesterday that OPEC would consider increasing production by 500,000 barrels a day when it meets on December 4. The news contributed to West Texas Intermediate WTI crude oil prices tumbling below $80 per barrel, causing a sharp sell-off in oil stocks.
OPEC denied the rumors by mid-day, helping prices recover, but the sell-off still left investors wondering if ‘safe’ energy sector bets had suddenly become riskier. Especially given oil prices tend to fall through the end of November.
Oil struggles over Thanksgiving
In “Oil Has a Crude History on Thanksgiving Week,” Real Money Pro’s Carley Garner writes:
“The crude oil market and Thanksgiving have a tumultuous relationship…Some of the largest and most devastating (to complacent traders attempting to enjoy their holiday) selloffs occur on or about Thanksgiving day…Last year, we saw oil futures fall $10 in the Friday trading session after Thanksgiving. Luckily, this was a half day, or who knows what the damage might have been. In 2018, oil dropped 10% on Thanksgiving week, and in 2014 oil dropped just under 14% on the shortened trading week.”
What’s behind the tendency for crude oil prices to perform poorly around Thanksgiving? Garner writes:
“There are a few logical reasons for the downside volatility, but I believe it can mostly be attributed to the last trading day for the December oil futures landing on this particular week. Other factors that play a role in the chaos are the presence of a late-November or early-December OPEC meeting and lightened trading volume due to the U.S. holiday and market closures.”
A cynic might argue oil production increase rumors were designed to give traders cover to flatten out positions before the holiday. The trend for oil prices has been lower since November 7, so somebody somewhere could have made a lot of money covering during that early morning sell-off. Or, perhaps, OPEC was floating a trial balloon because it wants to sell more oil at high prices before a global recession causes demand and, thus, prices to fall off a cliff.
The cartel agreed to cut production by 2 million barrels per day in October, so keeping production unchanged at the December meeting could be considered bullish, given the rumors planted a seed of doubt about whether they’ll stick to that target.
Regardless, yesterday’s craziness could give long and short investors reason to pause until OPEC’s meeting rather than place big directional bets during a more easily manipulated, light-volume trading week.
What happens after OPEC’s December meeting?
Weakness could set the stage for West Texas Intermediate and Brent crude oil to find footing next month because oil prices tend to bounce back after November sell-offs. Garner writes:
“According to our friends at MRCI (Moore Research Center, Inc)...going long oil on or about November 29 and holding through January 5 has been profitable in 12 of the previous 15 occasions.”
If history rhymes, that could mean a retreat in oil prices ahead of OPEC’s December 4th meeting could provide the tinder for a move higher. If so, it begs the question, “at what price is oil a short-term buy?”
“Looking to the chart for guidance, we caution against trying to aggressively buy the dip going into Thanksgiving. Should trendline support near $75 fail to hold, we would likely see a quick move to the long-term uptrend support level of $70…According to the chart, somewhere near $70, or $65 if the optimistic traders are lucky, would be a place to consider getting comfortably bullish. Of course, the $70 area may hold, and a rally might ensue from there, but according to both seasonal and technical analysis, the odds favor a further washout before stability and strength are probable.”
A drop could mean top oil stocks struggle.
“In this daily bar chart of the XLE, below, we can see some slippage in our indicators. Prices made a slight new high in November, but trading volume did not increase. The On-Balance-Volume (OBV) line looks like it equaled the June high and thus has made a bearish divergence. The Moving Average Convergence Divergence (MACD) oscillator has equaled its June high and has crossed to the downside for a take-profit sell signal.”
The MACD has yet to crossover on the weekly chart, though, and OBV is stalling but not showing the same level of divergence as it is on the daily chart. Kamich’s review of the oil and natural gas ETF’s point and figure charts suggests a downside price target of $80.
He concludes, “We do see some bearish divergences, and that is a warning flag, but the charts do not show us a clear top pattern. So, the XLE could correct further to the downside, but the charts do not say the bigger advance is over and done. Stay tuned.”
In short, there isn’t enough evidence yet to say that there aren’t oil stocks to buy, but some warning signals are flashing, making it important to see how oil and gas companies react in the coming weeks.
The Smart Play
Crude oil prices were already climbing early this year because of demand fueled by COVID-era easy-money policies and reluctance from the oil and gas industry to open spigots. However, they really took off after Russia invaded Ukraine, prompting sanctions on Russian oil. As a result, West Texas Crude soared from the mid-$60s in December 2021 to nearly $124 in June.
High prices have been a boon to energy profits. For example, ExxonMobil’s (XOM) – the second largest energy company behind Saudi Aramco – reported that third-quarter revenue was 52% higher than a year ago. That’s impressive, but the integrated oil company’s earnings per share increased by an even more remarkable 182%.
The oil and gas industry’s earnings strength has made it the best-performing sector this year. The SPDR Energy Select ETF is up 68%, while the S&P 500 ETF is down 16% this year. Since September, its gained 29% versus an 11% return for the S&P 500.
Energy stocks' substantial relative outperformance could lead to window dressing into year’s end by portfolio managers eager to show shareholders they own top stocks in the sector.
However, it will be harder for energy stocks to deliver similar top-and-bottom-line growth in 2023, given tough year-over-year comparisons. Moreover, while energy and gas producers do best in the late stage of the business cycle, performance is mixed in a recession, and energy underperforms in the early stage of the cycle. If we officially enter a recession next year, the energy sector's best returns may be behind it.
For this reason, using strength into year’s end to put some profit in your pocket or, at a minimum, move up stop losses could be wise. If global demand declines, causing oil prices to slip below 2022 levels, producers will have to rely on production to fuel additional growth rather than price. That could be good for energy services providers. Still, it may mean more supply comes to market as demand is falling because of a recession, further pressuring West Texas Intermediate and Brent oil prices. That would make it increasingly challenging for exploration and production companies, particularly as we push deeper into 2023.