Drilling down into the energy sector
01/17/18
Energy has been the S&P 500’s hottest sector over the past month, and over the past six months it trails only white-hot tech. The following chart pretty much explains the entire story:
March WTI crude oil (CLH8), 11/7/17 – 1/16/18

Source: OptionsHouse


As of yesterday, WTI crude oil futures (CL) were up approximately 6% on the year (and more than 12% from their early December swing lows), reaching levels not seen in three years. European Brent crude recently hit $70/barrel, and with March WTI crude (CLH8) approaching $65/barrel last week, some traders are wondering whether the US contract can hit the same milestone in the near future.

If oil does manage to extend its run, some traders may want to look at energy stocks in addition to crude futures. J.P. Morgan strategists, for example, recently noted that S&P 500 Energy stocks were undervalued by 10-15% relative to crude oil price levels.1 Traders interested in exploring this area should also keep in mind that of the two industries represented in the S&P Energy sector, Energy Equipment & Services stocks (+11.4%) were up approximately twice as much on the year as Oil Gas & Consumable fuels stocks (+5.5%) as of yesterday.

Superior Energy Services (SPN) is typical of many Energy sector stocks. The following weekly chart shows it turned higher just recently after basing near a long-term support level:

Superior Energy Services (SPN), 8/26/13 – 1/16/18

OptionsHouse


The daily chart below shows the stock has recently consolidated a little above the September 2017 high after breaking out above the December high at the beginning of the year. If the stock makes another push, the nearest chart targets are the July and May 2017 highs above $12 and the April high above $15 (or, alternately, the bottom of the 2016 range around $13.75—take another look at the weekly chart).
Superior Energy Services (SPN), 2/24/17 – 1/16/18

Source: OptionsHouse


The fuel for any continued run in energy stocks is, literally, crude oil. Even if some stocks in the energy sector have lagged crude’s rally and have room to catch up, a downturn in crude can render that point moot.

And some market observers are warning of a potentially overheated market. In this case, the “wall of worry” that crude bulls must climb includes the possibility that OPEC and Russia will abandon the production cuts that were initially intended to be in place until the end of 2018. Last week, for example, Iran’s oil minister said OPEC members were concerned that higher oil prices could rejuvenate US shale oil production (thus cutting into OPEC market share).2

Others point out that the current level of long crude futures and options positions held by hedge funds and other money managers is high enough to suggest an overbought market and an increased risk of reversal.3

There’s no telling how long the oil gusher will last, but after the recent run-up, even the most bullish forecast couldn’t rule out a short-term crude pause or pullback (yesterday’s decline was just the fourth down day for March crude futures since December 14). Until the uptrend is clearly broken, though, energy sector stock plays could have untapped potential.

 

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1 Marketwatch.com. How to best play the oil rally — and it’s not by buying WTI or Brent. 1/16/18.

2 Reuters. OPEC's cheer over 2018 oil rally tinged by shale worries. 1/9/18.

3 Reuters. Hedge fund bulls have left oil market looking very stretched. 1/16/18.