Is Big Oil Headed for a Big Bust?

Last week the oil market slipped into a bear market with prices down nearly 20% from their peak of $66.80 per barrel in April 2019. The quick pace of the downdraft came a surprise to some market participants. Both the supply and demand side are hitting the oil market at the same time. Demand for oil is weak, given concerns about the changing state of the US economy and uncertainty around the trade dispute with China and Mexico. For example, data from the US EIA showed America’s total petroleum stockpiles grew by a whopping 22 million barrels to the end of May, which was the most significant jump in data going back to 1990. At the same time, the market also seems concerned about a growing oil supply glut if the Organization of Petroleum Exporting Countries and Russia (OPEC+) fail to extend their volunteer production cuts to the end of the year.

Energy Sector ETF Under Pressure (XLE)

The poor state of the oil market is putting downward price pressure on energy-related ETFs like the Energy Select Sector SPDR ETF (AMEX: XLE). Performance of this fund has been relatively poor on both a long and short-term basis. For example, the total return in the last month is negative 6.9%, over the last year, negative 20.73% and over the last five years, negative 38.48%. Other parts of the oil value chain are not fairing much better. For example, the SPDR S&P Oil & Gas Equipment & Services ETF (AMEX: XES) is down 20.65% in the last month, down 48.68% in the last year and down a whopping 81.47% in the last five years.

Price Correction Could Be Problematic for Chevron’s Rosy Outlook (CVX)

The second most significant component of the XLE ETF is Chevron (NYSE: CVX), whose second-quarter 2019 earnings expectations are still favourable. There is some growing uncertainty if Wall Street analysts will soon revise down these expectations given the poor state of the oil market. Chevron surprised to the upside in its 1Q19 financial results with a 10.32% beat in their reported earnings per share of $1.39. Wall Street is forecasting earnings in 2Q at $2.01 per share and $7.38 per share for the FY19. Currently, Chevron has an analyst rating of 1.47, signalling a “strong buy” on a scale of 1.0 – 5.0 with 1.0 a buy and 5.0 a sell. The new rating is an improvement from 1.54 just three months ago. If oil prices keep trending lower, however, there is a risk of this rating weakening again.

Bottom Line

Some headwinds are building in the oil market simultaneously on the supply and demand side. Furthermore, it is anyone’s guess what could happen with US tariffs on China and Mexico. The global economy seems to be in a fragile place, and the uncertainty coming from current US foreign policy is not helping. If oil continues to trend lower at its current accelerated pace, market participants are likely to feel the pain. At the forefront of this firstly are the oil field service companies followed lastly by the integrated oil majors. Companies like Chevron are not immune, however, and there is a risk that the currently optimistic Wall Street outlook for this year’s earnings could be reworked.

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Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.