Have Energy Stocks Bottomed Out?

Most analysts avoid calling a top or bottom in the market, knowing the futility of such exercises. But sometimes you can sense when the worst is behind us, which I believe is now the case with energy stocks.

Of course, some may drop much further, especially those overly reliant on debt to finance their operations. Some of them will eventually go into bankruptcy reorganization, while others will be bought by opportunistic rivals. But those that survived the past year without irreversible damage should soon be on the road to recovery.

Energy stock behavior lately seems to show a transition in investor sentiment from extreme pessimism to guarded optimism. With the benefit of hindsight we can see that “big oil” stocks like Chevron and Exxon Mobil formed a strong baseline over the past three months—slightly higher highs and higher lows since their January lows.

Warren Buffett’s Berkshire Hathaway is also jumping on the bandwagon, taking a stake in troubled pipeline operator Kinder Morgan (KMI) after its share price plummeted 70% since April. Berkshire already has a huge stake in Exxon Mobil, which is a far less risky proposition than KMI. Adding Kinder Morgan to the mix shows that even a much smaller and less solvent energy company is now deemed “safe” to add to this mostly conservative portfolio.

Shadow Banking

What has gone almost unnoticed over the past several weeks is the resurgence of the energy sector’s shadow banking system: of master limited partnerships. You could have made a quick 50% return by buying Energy Transfer Equity (ETE) a month ago when it fell below $5; it’s now trading above $7.50. Or an easy 20% in less troubled Enterprise Products Partners, bouncing of its low of $20 to more than $24 over the past three weeks.

Even deep-sea oil drillers which had become toxic due to their high operating costs, are benefitting from renewed investor interest. Just this week the share price of Transocean (RIG) jumped more than 10% on Thursday, and SeaDrill (SDRL) saw its share price improve nearly 15% on the same day. That severe of a turnaround suggests that short-sellers have covered their positions in these stocks, allowing them to return to more equilibrium pricing levels.

Of course, all of this has to do with the price of oil, which briefly dipped below $30 a barrel in early February before climbing back up above $34 this week. Much of that is due to recent comments out of OPEC that it will voluntarily limit oil production to avoid worsening the glut in world petroleum inventories. It remains to be seen if all its members will cooperate, but that statement alone brings clarity to OPEC’s agenda.

All of that evidence is purely circumstantial, so stronger proof may be found in the futures market, which is populated by traders with access to the most sophisticated supply and demand information available. They are expecting increasing oil prices through the remainder of this year, topping out above $40 by this fall. That’s still considerably lower than what it was one year ago (near $60), but far above the $20/barrel price that was predicted at the beginning of this year.

If oil prices have bottomed out, then it may be time to begin buying select energy stocks. It takes guts to step in and start buying a group of stocks that have just gotten crushed, but that’s how big money is made. Although the price of oil may have a long, slow climb ahead of it, at least the days of its breathtaking descent may be over.