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Oil Below $40, Should You Buy The Dip In Energy Stocks?

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On December 8, Brent Crude oil fell below $40 a barrel for the first time since March 2009. As a result, the drop has sparked major conversations with concerns that oil may drop even lower than it did in this year. The drop in oil prices was largely triggered by an oversupply of oil in the market with no signs of slowing down as OPEC hit a production level that hit a three-year high. Due to this oversupply, traders are concerned that this could cause a lack of storage which could then lead to yet another drop in prices.

The reason for this sudden drop in oil prices can also be attributed to recent OPEC decisions. Last Friday, OPEC met and according to Reuters, they failed to agree to a production ceiling, as well as abandoned price support for crude through production.

In February, in our blog on oil stocks we said “In order for oil to become something of interest to us at Ideal Asset Management, prices would have to drop significantly below $40 a barrel and oil stocks would have to drop more than 20% from current levels.” We also stated that the Saudis, who have huge impact on the oil industry, have no incentive to cut production until oil drops well below $40 a barrel. Perhaps this most recent drop will affect their actions.

As the price of oil drops below $40 a barrel, our team believes that it may still be too early to add energy stocks to your portfolio. Last week, Chevron and Conoco Philips announced plans to cut spending by 25% due to continuing weakness in oil prices. If oil prices continue to decline, further spending cuts are likely. This would put continued pressure on oil stocks. Additionally, as the Federal Reserve has started to raise interest rates, it will be hard for oil to mount a strong rally.

Reflecting back on our previous blog, we believe that the Saudis are not likely to cut production until widespread bankruptcies take place in the US fracking industry. In our view this is not likely to happen until the middle of 2016 at the earliest. Therefore, although it is tempting to pick up beaten down energy stocks, it may be beneficial to wait for fundamentals in the oil industry to improve before pulling the trigger.

 

Disclosure:

All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC
Before trading on any of the information in this article, consider consulting your financial advisor to make it suits your financial goals
All investments carry the risk of loss

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