A large gathering of experts in the oil market met in Singapore this week at the APPEC conference. Most of the experts at the meeting were bullish about the prospect of higher oil prices. The prevailing opinion early in the meeting was that Saudi Arabia and Russia would stick to their current production cuts.

They were correct. Oil prices spiked higher on 9/5/23 as the Saudis and Russians confirmed the experts’ opinion by announcing they will keep the production cuts in place for the remainder of the year.

Regular readers of my columns weren’t surprised.

But the oil markets can be fickle. Given the huge rally in crude oil and in many oil stocks over the last three months, this is a great time to review where we are.

Ever since May 2023, I’ve been bullish on the oil market based on the premise that global supplies are tight, consequently creating a classic supply squeeze scenario which leads to higher prices.

When I wrote the article linked above, the price of crude was in the mid-$60 per barrel range. As I write, the price of West Texas Intermediate Crude (WTIC) is well above $85/bbl, with the price of global benchmark Brent Crude nearing $90/bbl. That’s roughly a 30%-plus gain in price for the fuel that is supposed to be phased out by 2030 according to Western governments.

Whatever happens next will likely have long-term repercussions throughout the global economy.

Interestingly, the current tightness in supply is not resulting from natural causes. It is the direct result of the interaction between corporate decisions and government policies. As Western global governments have become increasingly supportive of renewable fuels, oil companies have cut production. Moreover, the lack of refinery capacity in the U.S. offers an additive effect to fuel supplies when demand increases.

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On the other hand, even though U.S. and North Sea exploration has slowed, oil companies have increased their efforts around the world. Major finds in Africa and South America have recently gathered headlines.

The result has been a multi-pronged shift in how investors should evaluate their oil-related investments.

The Supply Crunch Is Palpable

The price of crude oil has reached a major decision point. That’s because a lot of price appreciation and bullishness related to tight supplies has already been factored in. Still, there is clear evidence that the amount of oil in storage is being depleted rapidly.

My point is that there is plenty of conflicting data, especially about the future of oil supplies.

Currently, most investors are aware that OPEC + (the cartel composed of OPEC members plus Russia) has cut production and for now it’s sticking to it. However, some OPEC members, especially Russia, are well known for outright cheating on their production quotas.

Meanwhile the U.S. Energy Information Agency (EIA) supply numbers for the past three weeks have shown a stunning 31 million barrel draw down from American supplies, while the U.S. government is slowly refilling the Strategic Oil Supply (SPR).

Until proven otherwise, the decreased production engineered by U.S. oil companies and their international cohorts in OPEC + seem to have made a dent in the amount of crude oil that’s in store in the U.S., just as the U.S. government is starting to refill the SPR.

These factors are likely to keep supplies tight, unless demand increases, which will mean supplies will get tighter. The flip side is that a slowing economy could well decrease demand, in which case, price volatility is likely to increase.

Where The Money Is Flowing

Traditionally, large integrated oil companies, such as Exxon Mobil (NYSE: XOM) and Chevron Texaco (NYSE: CVX), have been the easy go-to vehicles for money allocated to the energy sector. And why not? Given their diverse assets and global presence, these big basket companies allow investors to participate in all areas of the oil market while paying attractive dividends.

Except, that’s not the way the big money has been made in oil these days. The price chart for Exxon Mobil is a prime example. Certainly, the stock is starting to show signs of life. The recent breakout above the $112 area is a sign that money is moving into the shares.

But a comparison of XOM’s stock to that of the U.S. Oil Fund (USO) shows that investing in crude oil directly has been a better bet over the last few months. As the price chart for USO shows, this exchange-traded fund (ETF) has gained nearly $20 per share since May 2023, when I predicted higher prices were likely for crude oil.

Moreover, as the big oil companies have lagged, the oil exploration sector, which features smaller and more nimble companies, has delivered big gains. The iShares U.S. Oil Exploration and Production ETF (IEO) closely mirrors the action in USO. Yet, the Accumulation/Distribution Indicator (ADI) shows a steep drop on 9/5/23 as short sellers try to move the price lower. That’s a sign that volatility may ensue.

The oil services sector, which provides materials, transportation, and general support services to exploration and production companies as well as oil majors, has been moving higher as well. The Van Eck Vectors Oil Service ETF (OIH) is tracing a very bullish chart pattern. If it can clear the $350 area convincingly, it will likely head higher in a hurry. Yet, as with IEO, the above ADI is a bit cautionary.

The reassuring sign on both charts is the On Balance Volume (OBV) line. Its rise signals that buyers are still coming in.

Watching The Laggards

The emerging rally in the big players like Exxon Mobil and Chevron Texaco suggests that investors are finally recognizing the situation in the oil patch. Those of us who bought early in the cycle are in a good position, while others are going to play catchup.

Yet, there are areas of the oil sector that are lagging, namely the refiner stocks. Consider the action in shares of Valero Energy (NYSE: VLO). This San Antonio, Texas company specializes in boutique gasoline and diesel blends required in places like California due to clean air laws.

The general look of this stock is bullish. It bottomed out in May along with the rest of the sector and has been moving steadily higher until recently when it failed to match the breakout in WTIC and the majors such as Exxon.

That’s a divergence of sorts. And that means it’s worth watching because if the rest of the oil stocks retain their bullish tone and Valero and the refiners fail to move up in tandem, it may suggest that fuel demand such as for gasoline and diesel may be decreasing.

Certainly, there are some seasonal factors to consider as refiners retool their facilities for winter grades and for a potential increase in demand for heating oil.

But here’s what concerns me about the Valero chart. While the ADI line has been rising, the OBV indicator has remained flat. That means that the gains in the stock are more due to short covering than to outright buying.

This is a sign that investors may be doubtful regarding the demand side of the oil equation over time. And that doubt may be an early sign that the rally may be running out of time or that a consolidation is approaching.

On the other hand, if OBV for Valero starts to pick up, it will imply that buyers are shedding their doubt as there are indications that fuel supply is picking up. Think transportation. e.g. diesel trains and trucks.

Bottom Line

Crude oil has been in rally mode for over three months. Tight supplies are well documented. As far as we can tell, OPEC + and U.S. shale producers are maintaining their production discipline. Oil exploration and oil services stocks have already rallied impressively.

The fly in the ointment is the always present possibility that OPEC+ and shale producers will start cheating on their production limits.

A worrisome sign is that refinery stocks are starting to diverge from the bullish dynamic of the sector. There may be a subtle divergence developing among refinery stocks. Moreover, a lot of bullish expectations about the price of oil have already been priced in.

Three months ago, it was impossible to find oil bulls. The recent APPEC conference in Singapore was full of them. In many cases, these are the same folks who were bearish at the bottom of the cycle.

I’m not implying that oil prices are about to fall aggressively. I’m just noting that the oil market is a quirky place to invest. Both bullish and bearish trends can reverse rapidly. Stay alert.

Editor’s Note: Dr. Duarte has given you invaluable investing advice. But we’ve only scratched the surface of his expertise.

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John Persinos is the editorial director of Investing Daily.

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