Oil’s rebound may not last – but great opportunities are coming

With the price of oil up 20% from its low, things are getting interesting in the oil sector. Investors who get things right will make a lot of money, says John Stepek.


The biggest ever fall in the number of US oil rigs could have sparked the market bounce

I saw a slightly surreal headline streak across the office Bloomberg terminal yesterday.

It said something along the lines of "Oil back in bull market".

That seems ridiculous. The oil price has just about halved since its high point of last year.

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And yet, the price of Brent crude has rallied sharply in the last few days. So sharply, that at around $54 a barrel, it's up around 20% from its lowest point the informal definition of a bull market.

The question now is can it last?

Oil's rapid recovery

On Friday, Brent crude saw its biggest one-day rise since 2009. And the gains continued yesterday.

What's got the oil sector excited again?

Firstly, oil companies are cutting back fast. The number of oil rigs at work in the US last week was slashed by nearly 100 the biggest drop on record, as Neil Hume notes in the FT.

Meanwhile, the oil majors are rapidly binning billions of dollars' worth of investment. On the demand side, US petrol consumption is picking up too.

Against all that, you have the fact that production remains high US production is at its highest level since the 1980s. Supplies remain high too. And oil cartel Opec shows no sign of cutting back.

A strike by US oil refinery workers won't help either. Workers are demanding better pay and conditions just as oil companies want to cut back hard. "A complete walkout could threaten up to 64% of domestic refining capacity", says the FT. If oil isn't getting refined into other products, that hardly helps with the oversupply situation.

It's also worth being aware that speculators' were betting heavily against the oil price. Short' positions bets that the price would fall hit a four-year-plus high at the end of last month.

You can't always read a lot into these reports. But when everyone in a market is betting one way, it doesn't take much to swing the price in the opposite direction, because there's no one left to sell (or buy, in a bull market).

So on this occasion, for example, the surprise dive in US rig counts could easily have made the market bounce, because even a tiny bit of bullish news would have short-sellers locking in profits and exiting positions, and shift the balance towards the bulls a little.

In short, this could easily be a short-term rebound.

Things are getting interesting in the oil sector

Lots of companies have borrowed and spent money on the basis of oil prices staying at $100 a barrel. Yet the market is only really just starting to wake up to the fact that this slide in prices is something that companies can't just shrug off.

The recent travails of troubled oil and gas group Afren show just how quickly things can turn sour. At the end of last month, it basically ran out of money. Since then, the company's shares have been bouncing all over the place in mad swings of hope and despair amid bid talks and funding extensions.

It's a taste of the sorts of problems the sector as a whole could face. And now the vulture funds are gathering.

Private equity firms, such as Apollo and Blackstone, are racing to raise money to invest in distressed debt' in the sector. They want to be ready to go bargain hunting as the casualties start to mount. Steve Schwarzman, Blackstone's chief executive, has described energy "as one of the best opportunities we've had in many, many years".

The point is that the underlying assets of these companies might have plenty of potential. It's just that the people who currently own them have backed themselves into a corner financially, and now they'll effectively be forced sellers.

I'm not sure that I'd be bold enough to be buying into tiny explorers or other very vulnerable oil companies just now. But the bigger players could benefit from all this, just as much as the vulture funds. They can pick up assets on the cheap and exploit them in the future. Those with the deepest pockets will be the ones best placed to take advantage

We'll have more on the most attractive-looking opportunities in the sector in the next issue of MoneyWeek magazine, out on Friday. If you're not already a subscriber, you can get your first four issues free here.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.