Shale Stocks Hit Jackpot After OPEC Cut

If you are an investor in the long-suffering energy sector, congratulations. This is probably a very good week for you. This is the kind of week that can make a year. On Tuesday morning, we alerted subscribers to buying opportunities on a pair of beaten down oil stocks. By Wednesday afternoon they had risen 23% and 30%.

What happened in a day to so dramatically change the outlook for these companies, and for that matter much of the energy sector? After a price war that lasted almost exactly two years, OPEC blinked.

Here is a quick review to get you caught up. Between 2008 and 2014 the shale oil boom in the U.S. put nearly 5 million barrels per day (bpd) of additional supply on the market. OPEC, fearing loss of market share, made an announcement at its November 2014 meeting that it would not try to balance this oversupplied market by making cuts, but would instead defend market share. Members of the exporters’ group then dumped another 2 million bpd into an already oversupplied market, expecting a price drop to maybe $50 a barrel would bankrupt most shale oil producers.

I argued in a CNBC appearance that OPEC had made a serious miscalculation, and followed up with an article on Forbes which has been viewed 186,000 times and counting. By my estimate the decision not to trim output was going to cost OPEC members at least $1 trillion in foregone revenue, but their hope was to recoup those losses eventually through higher prices.

The strategy was one that Saudi Arabia insisted upon, and the Saudis tend to call the shots for OPEC. That plan lasted two years, even as OPEC countries burned through cash reserves. Countries like Venezuela and Nigeria, lacking Saudi Arabia’s deep pockets, openly questioned the strategy on numerous occasions.

The Saudis tried to talk up the markets at various times, but their words rang hollow. In recent months, they sounded like they were getting more serious about taking action. One thing I have noticed from observing OPEC and Saudi Arabia over the past 20 years or so — the Saudis get what they want. And when they recently, openly declared support for production cuts, I thought it was pretty likely they would follow through.

Now they have. At an OPEC that concluded Wednesday in Vienna, the group announced that it will reduce output by about 1.2 million bpd by January. Saudi Arabia accounted for some 40% of the cuts and Iraq for 20%. Iran, Nigeria and Libya were exempted. Russia, which is not a member of OPEC, agreed in principle to cooperate by foregoing a planned production increase of about 300,000 bpd.

The market response was swift. Global prices for crude quickly jumped roughly 10% to about $50/bbl. Oil stocks surged, with shares of many shale oil producers up 20% or more. The only major energy segment that was left behind in this rally was the refiners, which typically see eroding margins when oil prices rise.

Earlier this week I saw an article that referred to OPEC as a paper tiger. But no other group has the power to move the price of oil so dramatically. Make no mistake: OPEC has signaled that it has had enough of $50/bbl oil. It will make additional cuts as needed to push prices higher.

Of course the risk for the cartel is that the shale oil producers will increase output to fill the void each time it cuts, but OPEC still produces 42% of the world’s oil. OPEC members control 71% of the world’s oil reserves. They know global demand is forecast to continue growing, so they can afford to play the long game. The lessons learned over the past two years won’t soon be forgotten, so this move by OPEC marks a strategy shift back to defending oil prices that will continue in the months and years ahead.

What should investors do? If you have been avoiding the energy sector, now is the time to get back in. Scanning the portfolios of The Energy Strategist and MLP Profits, I see many picks that gained 10% or more in the wake of the OPEC news. I believe this will be the start of a serious recovery. Consider subscribing to one our newsletters for timely, actionable advice on energy investments with a dramatically improved outlook.     

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

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