Oil & Gas Industry Outlook – March 2018

Posting its second annual gain in a row, oil prices closed 2017 up more than 12%. Keeping up the momentum, the commodity got off to a strong start this year with the West Texas Intermediate (WTI) crude futures climbing 7.1% in January. Though the benchmark tumbled 4.8% in February in the wake of a broad stock market selloff, crude continues to trade above the psychologically important $60 level.

Are the Prices Sustainable?

The sentiment in the oil market has not been this good in years, with U.S. crude prices hitting a more than three-year high of around $66 recently – a spectacular recovery from below $30 in early 2016.

Riding on the positive oil price momentum, the major oil firms like Chevron (CVX), BP plc (BP), Royal Dutch Shell plc (RDS-A) and Total S.A. (TOT) – all part of the ‘Big Oil’ group – recorded massive year-over-year growth in their top and bottom line. Both BP and Shell sports Zacks Rank #2 (Buy), while Chevron and Total carry a Zacks Rank #3 (Hold).

(You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.)

The key question is whether the rally can continue or will these gains be short-lived, having risen too far, too fast.

While it is extremely difficult to predict movements in oil prices, we have identified several drivers that support the commodity’s steadily rising trend. In particular, unlike other short-lived rallies over the past three years, we believe the current higher oil prices are a result of improving fundamentals, as discussed below.

Production Cut Deal Extension

One of the significant reasons why the U.S. oil benchmark soared, revolved around the expansion of the output-cut deal between OPEC and other major producers beyond March. True to predictions, the coalition prolonged the current dynamic for another nine months to the end of 2018.

The agreement, now renewed twice, keeps 1.8 million barrels a day (or 2% of global supply) off the market in an attempt to clear a supply glut. There’s no ignoring the fact that the cuts continue to narrow the market imbalances.

Sharp Inventory Drawdowns

Investors have pinned hopes of recovery over the U.S. Energy Department’s inventory releases that show multiple weeks of strong inventory draws in the domestic crude stockpiles, pointing to a tightening oil market. Oil stockpiles have shrunk in 35 of the last 47 weeks and are down approximately 110 million barrels since April last year. The gradual fall – stemming from a combination of lower imports and spiraling exports – has helped the U.S. crude market shift from year-over-year storage surplus to a deficit. At 423.5 million barrels, current crude supplies are 19% below the year-ago period.

Specifically, stocks at the Cushing terminal in Oklahoma – the key delivery hub for U.S. crude futures traded on the New York Mercantile Exchange – is down by almost 23 million barrels in the past nine weeks alone.

The Shift into “Backwardation”

The front-month WTI contract remains in a state of “backwardation” – a phenomenon when near-term oil futures trade at a premium to futures dated further out. Analysts consider this as a bullish signal with the so-called backwardated market helping flush out inventories by eliminating the incentive to put oil in storage.