OPEC’s Oil Cut: Big Deal or Big Dud?

“A day late and a dollar short.” When we were growing up, that was one of my father’s favorite expressions. Those words come to mind, when I scrutinize the latest deal among major oil producers to reduce crude output.

The signatories tout the agreement as a milestone that will shore up prices. True, it’s the largest production cut ever negotiated. But is it enough to pull the energy sector out of its bear market? Let’s look beneath the self-congratulatory tweets about the deal, to get the real story.

OPEC, Russia and other allied producers in a group known as OPEC+ agreed on Sunday to cut 9.7 million barrels a day in May and June, or roughly 10% of global output. The deal is part of a coordinated effort by Saudi Arabia, Russia and the United States to stabilize oil prices and by extension financial markets.

Great news, right? OPEC, Russia and the U.S. (the White House helped broker the deal) seem to think so, as do most of the media. I beg to differ.

For starters, history tells us that most production curtailments are quickly violated. There is no official mechanism for enforcing cuts and cheating regularly occurs.

In fact, the ink is barely dry on the deal and already the gamesmanship has begun. Saudi Arabia on Monday announced deep discounts for the oil that it sells in May to Asia. The House of Saud is trying to buy market share in major developing countries.

Moreover, under the agreement, the production cuts don’t take effect until May 1. Ahead of that date, the cartel’s spigots remain wide open. As of this writing, the world’s supertankers are getting filled with crude at a record pace.

Always remember my maxim about official pronouncements: Watch what they do, not what they say.

Canada, Brazil, Norway, and the U.S. already are cutting production, but their efforts won’t be enough, either. Despite Sunday’s agreement, the massive global oil glut is likely to persist into the foreseeable future.

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Sunday’s production agreement doesn’t come close to offsetting the steep decline in energy demand caused by the coronavirus. Because of the precipitous decline in economic activity, global energy demand is down about 35%. We’re witnessing the worst demand destruction for crude oil in history.

A drop in the ocean…

These headwinds for crude oil are accelerating. Economists at JPMorgan Chase (NYSE: JPM) are forecasting that U.S. gross domestic product (GDP) will plunge by 40% through the spring months. That would represent the worst quarterly GDP drop in U.S. history. Cutting oil production by 10% is a mere drop in a growing ocean of oil.

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During the economic downturn and stock market swoon caused by the pandemic, the energy sector has gotten hurt the worst. Year to date (as of market close April 13), the benchmark exchange-traded fund SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has fallen by a whopping 55.05%, compared to a decline of 13.06% for the SPDR S&P 500 ETF Trust (SPY).

As you can see from the following chart, the per-barrel prices of West Texas Intermediate (the U.S. benchmark) and Brent North Sea crude (the international benchmark) have plunged.

Balance sheets in the energy patch are loaded with debt but margins are shrinking. When the oil industry goes bust, the broader stock market often suffers collateral damage.

To be sure, lower energy prices benefit consumers and temporarily help companies that rely on oil inputs. But if energy prices get too low, it signals decreased demand and a slowing economy, which in turn spooks investors. And let’s face it: lower gasoline prices aren’t much good when quarantined consumers can’t drive anywhere.

Don’t just take my word for it. Goldman Sachs (NYSE: GS) also is unimpressed with the production cut deal. In a note Monday, the investment bank stated:

“The OPEC+ voluntary cut would only lead to an actual 4.3 million barrels per day reduction in production from the first quarter levels. Inland crude prices (West Texas Intermediate) will decline further in the coming weeks as storage capacity becomes saturated and expect further weakness in WTI time spreads and crude prices in the coming weeks, as already presaged on Friday, with downside risks to our short-term $20/bbl forecast.”

Energy producers are slashing capital spending, which clobbers the oilfield services industry. We’ll witness a tidal wave of bankruptcies and layoffs throughout the energy sector, with negative implications for the financial markets and economy.

Moves to make now…

Under these dicey conditions, how should you position your portfolio? Stick to your long-term goals and stay invested. The pandemic will inevitably pass and the economy will recover.

Systematically increase your exposure to stable companies that provide services that remain in demand despite economic downturns. Consumer staples and utility stocks are prime examples of “essential services” investment plays. Use stop-losses for any additional stock purchases.

I also suggest that you turn to the advice of my colleague, Jim Fink.

Jim Fink is chief investment strategist of the premium trading service, Velocity Trader. Jim has devised a proprietary investing system that can predictably multiply the gains of regular stocks.

By following just a few simple steps, Jim’s system allows you to take regular stock movements of 8%, 17%, or 34% and amplify them to generate profits of 100%, 300%, even 800%.

With Jim Fink’s trades, you don’t have to worry about headline risks. That’s because his trading methods consistently generate profits, regardless of pandemics, recessions or volatile oil prices. Want to learn Jim’s investing secrets? Click here now.

John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com