Oil stocks have performed in August because of the “re-balancing” of production with demand. Inventories fell by 500,000 barrels per day in July, with current stockpiles at just over 3 billion barrels.
The United States Oil ETF (USO) is one stock having a good month. The USO closed at $9.9 on August 11 and has spent most of the month over $10—after dipping as low as $8.71 in late June. The USO is widely viewed as a bellwether for the oil market as it includes both spot and futures prices.
Individual oil stocks have rebounded, too. Despite having a poor week, BP p.l.c. (BP) has spent most of August above $36, significantly stronger than it was during February and March.
Stock market growth is being driven by shrinking stockpiles—which basically means that excess supply is no longer dragging down prices. There’s a fairly simple explanation for that: US producers are slowing their rate of growth.
According to Energy economist James Williams of WTRG Economics, the “oil rig count has stabilized and, at best, will have only modest increases for the rest of this year. That means slower growth in US production.”
Demand for oil is also on the up. Year-on-year, global demand increased by 1.8 million bpd during the second quarter, and the International Energy Agency (IEA) expects daily growth of 1.5 million bpd for the year. Increased demand is expected in 2018, as well. Higher oil consumption has been driven by faster global growth.
Will Ramped-up OPEC Production Hurt Oil Stocks?
While demand is growing and US-based producers have become more cautious, the Organization for Petroleum Exporting Countries (OPEC) is pumping oil in higher quantities. A report by the IEA said that OPEC’s daily crude output increased by 230,000 barrels per day in July, hitting a 2017 high of 32.84 million barrels per day.
Higher production has exposed an important truth: OPEC’s deal to cut production is flailing. Last year, the organization’s members as well as several other major producers (including Russia) agreed to cut combined output by 1.8 million barrels per day in 2017 in efforts to raise prices.
The problem is, producers aren’t sticking to the deal. According to the IEA report, compliance fell to 75% in July, a new low. The 22 countries who agreed to the cut are pumping a combined 470,000 bpd above their commitment. That’s been a drag on both crude prices and oil stocks.
“There would be more confidence that a market re-balancing is here to stay if some producers party to the output agreements were not, just as they are gaining the upper hand, showing signs of weakening their resolve,” the IEA report says.
There’s a chance that increased OPEC production will not offset the combination of stronger demand and slower US production. However, if the deal falls apart completely, expect oil stocks to take a serious hit.
How Investors Should Approach Oil Stocks
As you can tell from above, it’s not easy to predict where global oil markets will stand later this year. However, it does look like the re-balancing is happening, even if it happens in fits and starts. The spot price for West Texas Intermediate has been above $49 per barrel throughout August—after tapping $50 at the end of July—and looks likely to settle. Brent Crude is a bit stronger, closing August 11 at $51.97 per barrel.
With higher demand and the drilling slowdown in the US, prices should stay above the low $40s they hit in late June. Our advice is to hold onto oil stocks for the time being, but to watch OPEC closely. If the deal holds up, oil prices should stabilize and even increase. If it doesn’t, oil stocks will take a hit.