Energy funds rally sharply

But oil bump could be short-lived

Jan 12, 2018 @ 5:00 pm

By John Waggoner

As the Standard & Poor's 500 soars higher, there's another bull market bubbling up: Crude oil. Black gold. Texas tea.

But before you sell the shack and move to Beverly Hills, keep in mind there's a whole lot of oil still in the ground and offshore, and the recent rally could be overdone.

The Standard & Poor's 500 stock index has gained 3.58% this year, including reinvested dividends, but energy funds have jumped 6.48%, according to Morningstar Inc. Those returns beat not only the blue-chip stock index but red-hot technology funds as well, which have jumped 5.07% this year.

So far this year, the stocks have beaten the commodity. West Texas intermediate crude rose to $61.73 a barrel Wednesday, up from $60.46 a barrel at the end of 2017. Nevertheless, crude has been on a roll: Prices bottomed at $26.19 in February 2016.

What's behind the rally in oil prices?

Weakness in the value of the U.S. dollar is one culprit, said Stewart Glickman, energy analyst for CFRA. Oil and the dollar tend to move inversely.

Another has been an increase in geopolitical instability. Iran, which has been wracked with internal turmoil the past few weeks, produces about 4 billion barrel of oil a day. Venezuela, a failed state, produces about 2 billion barrels a day, Mr. Glickman said.

"The past few years, the premium on oil prices for global instability went to zero, but it's making a recovery," he said.

The big worry about oil prices: The U.S. has been the largest non-OPEC oil producer for years, and shows no signs of letting up. When Saudi Arabia flooded the world with supply to squash U.S. fracking, U.S. oil producers responded by becoming more efficient.

"I think people are overlooking how much the U.S. can boost production," Mr. Glickman said.

Even at these levels, the recent move by the Trump administration to open up offshore drilling probably won't have a big effect on supply.

"It takes a lot of time to drill offshore, but you can start drilling in the Permian Basin in a week," Mr. Glickman said. Shallow-water drilling needs about $50- to $55-a-barrel prices to be worthwhile, while deepwater drilling needs about $75 a barrel.

Even if energy prices fall, midstream energy companies — pipelines — look to be in good shape. Before the collapse of oil prices, boosters of energy master limited partnerships noted that pipeline profits depend on the volume of oil pumped not the price of that oil. Unfortunately, in the event of a price collapse, producers simply decide to pump less oil.

Funds that invest in oil MLPs have gained an average 5.66% this year, according to Morningstar, and many still support high yields. Alerian MLP ETF (AMLP), for example, has a 7% 12-month yield.

"I don't have any real concerns about midstream energy companies," Mr. Glickman said. "They are now living within their means."

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