Knee Jerk reaction to oil prices volatility is senseless

Confused investors may miss opportunity

Friday’s sell off on oil stocks saw the trading prices fall 5% to 8% on key names as WTI fell almost 7%.

On May 18, 2022 WTI closed at $107.04 and today at $109.56. During the month, the WTI price was higher than $107.04 every day. Oil producers received more money for the oil they shipped every day for the past 30 days than they were receiving on May 18, 2022. So what do oil investors do? They panic and rush for the exit doors dumping oil stocks pell mell.

Whitecap (WCP.TO) opened the month (from May 17 to June 18) at CAN$10.70 and closed the period at CAN$9.77, a drop of 9%.

Cenovus (CVE.TO) opened the month at CAD$26.9 and closed it at $24.81, a similar drop.

Canadian Natural Resources (CNQ.TO) opened the month at CAD$81.33 and closed it at CAD$68.35, a drop of 16%.

Anyone else see a pattern here? Oil prices rise and oil stock prices fall? I am so old-fashioned I thought the reverse was how markets worked. Ask yourself, if the WTI price had been flat at ~$107 a barrel for the month would you expect oil stocks to get hammered? Didn’t the higher prices between May 17 and June 18th benefit producers by giving them higher cash flows? The market reaction reflects high volatility and high fear.

Markets look ahead, of course. There is every reason to believe interest rates will keep rising until they are higher than the neutral rate and higher than the inflation rate. Higher rates will mean lower stock prices generally and I suspect a deep recession is needed to curb inflation, which will cause demand for fossil fuels to fall.

The last deep recession was in 2008/2009. Despite the devastation that the global financial crisis inflicted on economies and markets, oil demand barely budged downward and promptly recovered.

Oil prices did fall sharply nonetheless as traders panicked, but recovered sharply as well. The volatility of oil prices is extreme and not for the faint of heart. The 2008 drop from close to $150 a barrel down to the $35 range must have given many oil investors ulcers, as did the March 2020 collapse when COVID first appeared and prices even went negative. But those bottoms were the greatest opportunities energy investors have had this century.

The likely recession will see demand fall for sure. But as I see it, supply may fall just as fast as demand if not faster. Only the United States has the ability to materially increase production rapidly and the Biden administration won’t let that happen. I can see WTI falling as low as $60 or $70 in a deep recession but at that price Whitecap, Cenovus and Canadian Natural Resources will still make a lot of money. So, rather than joining into the selling panic, I am adding to my holdings.

Less aggressive investors might want to keep a cash balance and wait for another extreme low in oil & gas prices to add to their exposure to energy. I am keeping my own balance sheet unlevered with a reasonable cash position, and remain bullish on the long term benefit of investments in oil producers with little or no debt and low operating costs.

Good luck with your investments. Note - the stock charts are from MSN Money.