MacroView – The Energy Rally Is Likely Premature

The rally in energy companies is likely premature. To understand why such may be the case, we have to review a bit of history.

In 2013, I began warning about the risk to oil prices due to the ongoing imbalances between global supply and demand. Those warnings fell on deaf ears as no one paid attention to the fundamentals. Then, with near-zero interest rates,banks, hedge funds, and private equity firms were chasing “yield” in the energy space. Naturally, with money flooding into the system, companies drilled economically unproductive wells to meet investor demands, which drove supplies higher.

A Bit Of History

It didn’t take long for previous predictions to play out. In May of 2014, I wrote:

It is quite clear the speculative rise in oil prices due to the ‘fracking miracle’ has come to its inglorious, but expected conclusion. It is quite apparent some lessons are simply never learned. “

Since then, OPEC has engaged in repeated rounds of cutting production to support oil prices. While there was a short-term success from those actions, ultimately, U.S. “shale” producers outpaced those cuts with new supply. In September of 2017, we again reviewed the fundamentals warning investors of the risk.

“While there is hope production cuts will continue into 2018, a bulk of the current price gain has likely already been priced in. With oil prices once again overbought, the risk of disappointment is substantial.”

Then, as 2018 came to a close, I made an important observation:

“Prices of both energy-related shares and oil have been disappointing. The expected decline in oil prices is more important than just the relative decline in share prices of energy-related stocks. Energy prices are highly correlated with economic activity.“

That bit of history helps frame our reasoning why the rally in energy stocks is likely premature. The fundamental issues of supply, demand, sector debt, and weaker economic growth rates remain problematic.

Economic Recovery Will Remain Weak

The 33% surge in economic growth in Q3 was certainly welcome. However, the recovery was not a function of organic activity. Instead, it was a function of massive Government stimulus which pulled forward future consumption.

As is always the case with Government largesse, recycling “tax dollars” may appear to create activity. However, the illusion quickly fades along with the stimulus. Such is why, despite zero interest rates and Central Bank interventions, economic growth rates continue to decline. As we showed previously:

“Before the ‘Financial Crisis,’ the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.”

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