The Energy Letter is published each week on Tuesdays and Thursdays. The purpose of these columns is to cover important happenings in and around the energy sector, especially as it pertains to energy investments. When I do discuss investments in The Energy Letter, I usually take a big picture view. For example, I might focus on the resurgence of oil production in the Permian Basin, or the impact of President Trump’s policies on renewable energy.

Readers looking for more specific guidance might consider subscribing to The Energy Strategist. That’s where I narrow down the big picture to specific investments that I believe are poised to outperform peers in the energy sector.

Each week when I am deciding what to write about, the highest priority is usually to address any especially important stories in the sector. This week, that was OPEC’s decision to maintain production cuts, which I covered Tuesday in OPEC’s Decision Will Balance The Oil Market. For my other weekly column, I will typically choose from any number of current energy stories. Last week there were just too many interesting stories, so I did a roundup of brief stories. Readers have told me in the past that they like to read these news briefs, so I may make this a semi-regular feature.  

Time To Buy?

The energy sector has gone from first to worst. Energy finished as the top-performing sector of 2016, but the Energy Select Sector SPDR ETF (XLE) has dropped 13% so far this year. The S&P Oil & Gas Exploration & Production SPDR ETF (XOP), which is more representative of the smaller-cap drillers, rose nearly 40% in 2016 but is down 21% year-to-date. 

Energy stocks are down this year, and the sentiment has been bearish. In a recent article, Barron’s wonders if it’s time to buy energy stocks. The article cites three factors pointing toward better times for the energy sector.

First, oil futures are moving into backwardation, which has historically meant that oil supply/demand fundamentals are moving into balance. Second, energy credit default swaps (CDS) and high-yield (HY) spreads have rallied sharply this year, reflecting improving fundamentals, and consistent with an oil market in stable backwardation. Finally, energy stocks have lagged so badly this year that energy is the only sector in the S&P 500 where equity and CDS/HY have diverged. Past divergences have favored a catch-up in equities.

The article mentions four stocks that passed their screening criteria. Two of the companies they mentioned are in the portfolios of The Energy Strategist, but all four are attractively valued at present in my opinion.  

The Gift Of Fracking

I doubt that most people realize just how much money they are saving as a result of hydraulic fracturing. But had fracking not come on the scene when it did, Americans would probably still be dealing with oil prices above $100 a barrel and natural gas prices of two to three times what they are today. 

Just consider gasoline. CNBC reports that the national average price for unleaded gasoline on Memorial Day was $2.37 per gallon, which is about $1.30/gal cheaper than it was just three years ago. U.S. consumers use about 140 billion gallons of gasoline a year, which means consumers are saving about $180 billion a year just on gasoline.

Add in the savings in diesel, jet fuel, heating oil, and the 27.5 trillion cubic feet (Tcf) of natural gas we used last year, and fracking is easily saving Americans several hundred billion dollars a year on their energy costs. That’s money that would have largely gone overseas to OPEC, but that is now freed up for consumers to spend or save as they wish. 

Inventories Set To Fall?

The market was underwhelmed by OPEC’s decision to continue with the production cuts they decided on last November (apparently expecting deeper cuts), but there are signs that inventories are finally headed back down. Reuters reports:

Oil traders and analysts are expecting large volumes of crude to draw from storage tanks across the United States in coming weeks, in what would be the most tangible sign of an inventory overhang reduction that has punished prices over the last two years. A reduction would show the market is finally reversing course after years of stock builds that left a worldwide overhang of half a billion barrels of crude oil and refined products.

The article goes on to state that Saudi Arabia’s oil minister was pleased to see seven straight weeks of U.S. crude oil inventory draws and a drop in floating storage. He also noted that exports to the United States are falling measurably.

I have stressed many times that substantial inventory reductions will indicate that the OPEC cuts are having the desired impact. There are multiple lines of evidence that this is finally beginning to take place. Should there be a significant inventory draw in the 2nd half of the year, don’t count out $60/bbl oil for this year just yet.

Finally, there are rumors that President Trump is going to withdraw the U.S. from the Paris climate agreement. Should that happen, I will address the implications in a column next week.  

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