Many of you have witnessed the dramatic drop in the price of oil and watched in awe as Canadian energy stocks have given up almost half their value since September.
Investors like you want to know a few things, mainly, have we found a bottom yet in the price of oil? Is now a good time to buy energy stocks? Is now a good time to sell energy stocks? And who will take home the Season 7 crown of NBC's reality TV show, The Voice?
I'll spare you any suspense in the interest of time and give you my shorthanded answers to each question proposed above: it looks like it, no, probably, and Craig Wayne Boyd. Before we go any further, let's first recap what's happened so far this year within the energy complex.
The price of oil peaked in the summer at more than $100 per barrel, but slowly began to fall in July. The drop was not dramatic though and we seemed to find a bottom around $90 a barrel in September.
Why did the price come off? There were a few reasons. First, we saw extra supply come onto the market from places like Libya and Iraq. This is simple economics 101 - increased supply, all else being equal, will put pressure on prices. Next, geopolitical concerns from places like Ukraine and Iraq (remember how ISIS was going to take Baghdad?) which were supporting prices, eased. The final blow came from a surge in the value of the U.S. dollar. Oil (and all commodities for that matter) is priced internationally in U.S. dollars, so when the U.S. dollar rises, it causes the price to fall.
But oil did have one last life line. OPEC, a cartel of oil producers responsible for about a third of global oil production usually moves to support prices in times of weakness by cutting production to balance out supply and demand, as they did in 2008. This time around OPEC, and the Saudis in particular, seemed more concerned with defending market share than the price of oil. Once OPEC formally announced they would not cut production to support prices, oil took another tumble.
These factors were the catalyst for the decline, but the overarching theme for the weakness in oil is an oversupplied world. Put simply, the world is producing more barrels of oil each day than it's consuming.
The price action for oil is the market telling producers to get things in order, or in other words, get supply in line with demand. This is the fundamental basis for the old proverb, the remedy for low prices is low prices. Lower oil prices will flush out a lot of the marginal producers from the market as they cannot produce oil economically at these levels.
The U.S. shale formations will be the hardest hit, but this process will take place over a period of 12 to 18 months, and possibly longer.
We reduced our energy exposure to essentially nothing in October and November and believe it's still too early for investors. You may want to consider selling your hardest hit energy stocks for tax loss purposes, but be sure to check with your advisor and accountant before doing so. Energy stocks will rebound at some point, but we need to see some stabilization in the price of oil first. Furthermore, the necessary process of supply destruction will not happen overnight.
Energy stocks may be bottoming now in fact, but risks are still elevated and there are better investment opportunities out there.
Remember, there is a large universe of investments and you don't have to be in energy.
Lori Pinkowski is a portfolio manager and senior vice-president, Private Client Group, at Raymond James Ltd., a member of the Canadian Investor Protection Fund. This is for informational purposes only and does not necessarily reflect the opinions of Raymond James. Lori can answer questions at 604-915-LORI or [email protected]. Listen to her every Friday on CKNW at 5:35 p.m.
