OPEC+, Revisited

On Sunday April 2, 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. Brent crude oil prices jumped that Monday, notching their largest one-day jump since March 2022, when everyone freaked out over Western sanctions against Russia causing severe supply disruptions. After early-April’s announcement, most headlines presumed further rises were sure 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. And now? Few seem to have noticed, but oil has erased that spike and then some, taking 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 quickly realized 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, 12/31/2022 – 5/4/2023.

This hasn’t been great for global Energy stocks, which were last year’s darlings. Year to date, they are down -6.9%, while the MSCI World Index is up 7.5% through Thursday’s close.^[i] That is quite the gap. Even more interesting 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 darned 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, 12/31/2022 – 5/4/2023. Indexed to 1 at 12/31/2022.

When you consider what drives Energy stocks’ earnings, this shouldn’t surprise. They are most sensitive to oil prices, not production volumes—largely due to each oil well’s high up-front costs. Higher oil prices are 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.^[ii] 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 expect Energy stocks to keep falling from here. Global oil supply and demand appear pretty well-balanced, which points to oil prices staying pretty range-bound. Current prices are high enough to keep producers nicely profitable. But last year’s gangbusters Energy earnings growth rates are highly unlikely to repeat, given the year-over-year comparison is now pegged to higher oil prices. Furthermore, the equity rally since October increasingly looks like a new bull market, and bear market leaders usually lag after the low. Energy was the biggest winner last year. So there are likely better opportunities in other sectors and industries. Energy stocks can still help with diversification, but we suggest not going hog wild.