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posted on 26 November 2017

Crude Reckoning: Stocks Soar But OPEC Meeting Looms Large

by John Persinos,

Investing Daily Article of the Week

The major market indices closed sharply higher lastTuesday amid renewed optimism over economic growth. The retail and technology sectors gained the most; consumer non-durables and energy fell the hardest.

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A catalyst for the upturn was a bullish report released Tuesday by Goldman Sachs (NYSE: GS). The investment bank said it expects the S&P 500 to rise 11% in 2018.

Other banks this week issued similarly optimistic projections. They call for double-digit stock market gains next year. As for a correction… fuggedaboutit. The consensus is that growth will keep a downturn at bay.

But during this holiday-shortened week, the most important news for investors isn’t crystal ball gazing from investment banks. It’s the OPEC meeting scheduled for November 30 in Vienna.

The equity markets and energy prices often move in tandem. The fortunes of your portfolio and those of the energy patch are intertwined. With next week’s OPEC meeting looming over Wall Street, now’s a good time to spotlight the energy sector.

Fracking: Born in the USA…

Topping the agenda of the November 30 summit is the agreement among OPEC and its partners to curtail oil production. Brokered by cartel leader Saudi Arabia, the deal has kept a floor under prices.

But reports surfaced Monday that Russia will say nyet to Saudi Arabia’s request to extend the cut beyond March 2018. Russia is the world’s top producer and exporter.

Vladimir Putin holds the cards, as usual. Even under the existing production cut, the wily Russian president pulled a fast one. He negotiated a sweetheart deal.

Russia’s production curbs are minor. But if Putin walks out of the deal next week, the whole shebang unravels. Other members would walk out, too. Production would soar. Oil prices would plummet. Markets would tumble.

Oil prices are higher than they were in February 2016. That’s when they fell below $28 per barrel. But they’re still down 50% from their highs of $110/bbl in mid-2014.

This year, energy prices have plateaued and hover in a narrow range. Energy stocks have under-performed.

The Energy Select Sector SPDR ETF (XLE), Vanguard Energy ETF (VDE), and SPDR S&P Oil & Gas Exploration & Production ETF (XOP) have generated year-to-date declines of - 7.48%, -9.36%, and - 16.60%, respectively. The S&P 500 year-to-date has risen 16.68%.

Oily Chicken Littles…

Perhaps you’ve heard TV pundits yammer on about “peak oil."

In theory, peak oil occurs when the maximum rate of crude oil extraction is reached, after which the rate of extraction begins to decline. As the population continues to rise, oil production can’t keep up with growing demand.

Peak oil adherents envision scenarios out of a Mad Max movie: sky-high oil prices, energy shortages, economic havoc. People shooting each other in gas lines.

There’s only one problem with peak oil theory. It’s a bunch of hooey.

I turn your attention to World Energy Outlook 2017, released last week by the International Energy Agency (IEA).

The report concluded that America would become a net exporter of oil within a decade. In fact, the U.S. is on track to becoming the world’s leading oil and gas producer for decades. The IEA estimates that the U.S. will account for 80% of the world’s new oil production through 2025.

Because of hydraulic fracturing and horizontal drilling, previously unavailable oil deposits are now cheaper and easier to extract. American oil production has surged.

This “fracking" revolution blindsided the peak oil crowd. It also threw a curve ball to the House of Saud.

The Saudis launched an oil price war in 2014. By throwing open the spigots, they drove down the price of oil. Their goal was to bankrupt U.S. shale producers.

The Saudi plan backfired. Spectacularly.

The fracking technology devised by U.S. engineers has been so ingenious, domestic producers have been able to pump oil at extremely low cost. OPEC’s cost of production is much higher.

That means American energy producers win, even if OPEC ultimately loses.

But the net effect has left global markets sloshing with an excess of cheap crude, which in turn weighs on oil prices. That hurts the top and bottom lines of indebted energy companies. The losers in the U.S. energy patch have been those firms that racked up the most debt to expand during the go-go days leading up to 2014.

This energy paradox won’t end anytime soon. It certainly won’t get resolved in Vienna on November 30. And it could trip up this bull market.

Ahead of the meeting, bullish sentiment in the energy sector has eased. But prices are holding steady. On Tuesday, West Texas Intermediate gained 53 cents to close at $56.95. Brent North Sea crude gained 36 cents to close at $62.58.

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