Stocks hit by oil weakness -- and it's set to continue
Wall Street was slammed again on Tuesday, with the Dow Jones Industrial Average losing 160 points, or 0.9 percent, and falling below critical support at its 200-day moving average.
Energy stocks were hit especially hard after oil prices fell to seven-year lows. The Energy Select SPDR (XLE) touched lows not seen since late September and is down nearly 17 percent from its early November high.
Investors are reacting to Friday's decision by OPEC oil ministers, waging a price war with U.S. shale producers, to keep production at 30 million barrels per day, a quota that's been in place since 2011. In early trading, West Texas Intermediate fell to touch $36.60 a barrel, a level not seen since early 2009.
The weakness in energy stocks looks set to continue until OPEC cuts production. Officials from Indonesia warned that an emergency meeting would need to be held if oil prices fell below $30 a barrel. Until then, a change in strategy is unlikely.
While U.S. drilling rig counts have fallen, U.S. shale producers have refocused on low cost/high productivity wells to keep production relatively stable. By contrast, offshore production is rising, according to the U.S. Energy Information Administration, driven by the desire of oil companies to complete these complex and costly wells once they've begun.
Although OPEC's official ceiling is around 30 million barrels per day, Oil Market Intelligence reports that cartel members produced at a near-record pace of 38.8 million bpd in October at the same time non-OPEC producers pumped a record 57.2 million bpd. Poorer OPEC countries are being forced to pump more oil, despite lower prices, to try to help minimize the overall hit to revenues.
With manufacturing activity slowing globally and in the U.S., the world is simply awash in too much oil. It's simple supply and demand.
And with prices so low, global oil revenue is collapsing, down 56 percent from last year's peak, according to Yardeni Research. That will continue to weigh on the earnings of energy companies like Chevron (CVX), in October reported a 37 percent year-over-year drop in revenue.
Over the horizon, Capital Economics believes oil prices should recovery in 2016, regardless of what OPEC does, as lower prices continue to weigh on investment in new energy production. The research firm also assumes global oil demand bounces back as economic growth around the world accelerates and the pumped-up dollar weakens.
When, and if, that happens, low energy prices will keep weighing on stocks via the impact on energy sector earnings. Already, according to FactSet, fourth-quarter S&P 500 earnings are expected to decline 4.3 percent over last year in what is set to be the third consecutive quarter of declining profits. That hasn't happened since 2009. Energy sector profits are expected to decline 65 percent over last year.
In September, the projected decline in fourth-quarter earnings was only 0.6 percent. No wonder investors are in a selling mood.
