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Where the Energy Sector Goes From Here

by | published October 22nd, 2014

With the stock market now roaring back, investors are left to wonder whether the worst is behind us – or if there’s more pain yet to come.

Given the size of the sell-off, it’s clear a slew of folks expected a “correction,” and to that extent received a self-fulfilling prophecy.

However, at times the decline was more like a snowball cascading down a hill with no overall rhyme or reason.

Of course, there is always the possibility that we could revisit this roller coaster again in the short-term, but it is quite unlikely to have the same velocity.

Hit particularly hard during this slide was the energy sector.

And while every segment of the market felt the brunt, energy seemed to drop with a vengeance… but it didn’t last for long.

As the market bottomed out, energy stocks lead the recovery, posting big advances.

So what do the latest market gyrations tell us about the energy sector?

Here’s my take on where the markets go from here…

Why the Underlying Fundamentals Still Rule

Forget for a moment that some pundits still insist the losses are not over.

There seems to be a “magic formula” circulating among a few of these guys that requires a 10% correction before the patient can leave intensive care.

If they are right (and I doubt it), the decline still has some legs.

Yet, I have never signed on to the idea there are sacrosanct levels markets must reach before it returns to “health.” This has usually been more of an exercise in which these same “analysts” are short and then run on TV to assure the losses hit, earning themselves a nice profit.

We also had a clear indication this time around of how computerized trading patterns and “flash trades” can distort actual market conditions. The rapidity of the flood took even floor veterans by surprise.

But as my Money Map Press colleague Keith Fitz-Gerald often reminds us, “The market is the market. When it is advancing you get on the train. When it is moving down you get out of the way.”

I have always found that to be useful advice. It takes the emotion out of the trade.

But the broader markets usually aren’t that rational. The first move in either direction is initiated by emotion and then extended by “extra-market” trading methods.

It’s sort of like having a disturbed patient on steroids.

Nonetheless, one overarching fact remains clear. Once the children have had their temper tantrum, certain givens return and dictate most of the market activity most of the time.

Some traders may think markets have a life of their own, with the opportunistic snake oil salesmen out there trying to sell you a simplistic cure for everything based on the latest “discovery.”

But the reality is altogether different: Underlying fundamentals rule, not abstract trading programs and algorithms.

These artificial constructs will occasionally accentuate a move in one direction or the other, but they cannot cause the market to move lower or higher for any length of time.

The Inescapable Truth: The World Runs on Energy

As for energy, if anybody had doubts about the importance of this sector, the back and forth movements of the past few weeks should dispel them.

It is true. Energy led the move down. But when a frantic recovery emerged, the same stocks advanced faster than the market as a whole.

In fact, the losses experienced in the leading shares in both the Energy Advantageand Energy Inner Circleportfolioswere not only erased in the last three trading sessions, all of them are now ahead of where they were less than a week ago!

Here’s why: Energy prospects are no longer determined simply by the price of the raw materials.

As a case in point, consider this. The slide in crude oil prices may have been the catalyst that caused the decline, yet when a floor formed in those prices without a significant spike, oil stocks shot up across the board.

In reality, those stocks had become badly oversold, and responded to the upside more on fundamentals than simply a fluctuation in price.

My own view on price is rather simple. The energy sector will do fine and earn handsome profits in traditional projects (i.e., vertically-drilled non-shale) with oil anywhere north of $65 a barrel. Meanwhile, on average, unconventional shale and tight oil requires a price somewhere in the mid-$70 range.

This simply means those companies with competitive factors in their favor (operational expenses, location, managerial ability, and the like) will push out the less profitable competitors.

It also means investors need to be more careful when deciding where to invest.

Despite what the TV talking heads want you to believe, the energy sector does not all march to the same drummer.

What is true it this inescapable reality. Without exception, every sector in the market is dependent upon the availability of energy.

The key is to play these market changes profitably, not fret about them.

After all, you can’t expect the market to ignore the most basic underpinning of all economic activity for long.

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  1. October 23rd, 2014 at 01:57 | #1

    I worked with an Iranian businessman once who said, “Americans are smart…they use everyone’s oil and saves their own.” With the production of US oil, prices are now dropping at least partly due to oversupply. To me, this makes the Keystone pipeline issue irrelevant for now. However, I support a two-part policy: build the pipeline and use Canada’s resources, while states like Texas should limit how much is taken from Permian and Eagle Ford each year. I am a Texan and I know ghost towns created by past oil booms after the wells dried up. It seems we should learn something, after all, the price of the resource in 2030, for instance, is likely to be much better than 2014.

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