OPEC+, Revisited

On Sunday 2 April, the Organization of the Petroleum Exporting Countries (OPEC) and the countries that partner with it on supply targets—collectively known as OPEC+—upended a pleasant weekend by announcing they would cut production quotas by 1.66 million barrels per day.^[i] Brent crude oil prices jumped that Monday, notching their largest one-day jump since March 2022, when Western sanctions against Russia prompted many commentators we follow to warn of potentially severe supply disruptions.^[ii] After early-April’s announcement, most headlines we encountered asserted further rises were likely to follow, with calls for $100 per barrel or higher common. But as we wrote then, this seemed hasty, considering OPEC+ had long undershot production targets and past quota cuts hadn’t much dented output.^[iii] And now? Few commentators we follow seem to have noticed, but oil has erased that spike and then some, which we think has the wind out of Energy stocks’ sails in the process. We doubt they regain leadership in the near future.

Exhibit 1 shows Brent crude oil prices this year to date. As you will see, they have been pretty bouncy, but earlier spikes didn’t last. OPEC+’s announcement arguably triggered a larger move, but it was similarly short-lived as markets seemed to realise quickly it wouldn’t materially change global supply and demand.

Exhibit 1: Oil’s Round Trip

Source: FactSet, as of 5/5/2023. Brent crude oil price, 31/12/2022 – 4/5/2023. Please see the end of this article for a longer-term depiction of these data.

This hasn’t been great for global Energy stocks, which were amongst last year’s top performers.^[iv] Year to date, they are down -10.9%, whilst the MSCI World Index is up 2.8% through Thursday’s close.^[v] That is quite the gap. Even more interesting, in our view, is the trajectory of those relative returns, which Exhibit 2 shows. In this image, Energy is beating global markets when the line is rising. As you will see, the trajectory follows oil prices pretty closely, with a similarly short-lived boomlet in early April.

Exhibit 2: Energy’s Relative Returns Followed Oil

Source: FactSet, as of 5/5/2023. MSCI World Index and MSCI World Index Energy returns with net dividends, 31/12/2022 – 4/5/2023. Indexed to 1 at 31/12/2022. Please see the end of this article for a longer-term depiction of these data.

Considering what Fisher Investments’ research finds drives Energy stocks’ earnings, we don’t find this surprising. We find they are most sensitive to oil prices, not production volumes—largely due to each oil well’s high up-front costs. Higher oil prices will therefore be generally necessary to recoup that investment and generate profits in the long run, regardless of whether production is high or low. Because of this, Energy stocks’ relative returns are pretty highly correlated to oil prices. Over the past 20 years, the correlation between them is 0.6.^[vi] This figure is the correlation coefficient, which is a statistical measure of the relationship between two variables. Considering a correlation of -1 means they always move in opposite directions, 0 means no relationship and 1 means they always move together, 0.6 means they move together much more often than not.

We don’t necessarily think Energy stocks are likely to keep falling from here. Global oil supply and demand appear pretty well-balanced, based on our research, which we think points to oil prices staying pretty range-bound. Current prices appear high enough to keep producers nicely profitable. But last year’s white-hot Energy earnings growth rates are highly unlikely to repeat, given the year-on-year comparison is now pegged to last year’s higher oil prices and earnings.^[vii] Furthermore, the equity rally since October increasingly looks like a new bull market following last year’s global bear market in US dollars, and our research finds bear market leaders usually lag after the low.^[viii] Energy was the biggest winner last year.^[ix] So we think there are likely better opportunities in other sectors and industries. Energy stocks can still help with diversification, but we think limited exposure is likely the beneficial approach.

Annex 1: A Five-Year Look at Oil Prices

Source: FactSet, as of 5/5/2023. Brent crude oil price, 4/5/2018 – 4/5/2023.

Annex 2: A Five-Year Look at Energy Stocks’ Relative Returns

Source: FactSet, as of 5/5/2023. MSCI World Index and MSCI World Index Energy returns with net dividends, 4/5/2018 – 4/5/2023. Indexed to 1 at 4/5/2018.