By Michael Wuetherick, P.Eng. User Group Leader: Red Deer Alberta February 15, 2015

Energy Sector Update – Is the rotation back into Petroleum stocks underway?

Is the Petroleum sector starting to show signs of hitting a bottom, or is it perhaps behind us already? The message in my last blog on January 11th, 2015 was to watch closely for signs of weakening US industry output as measured by changes to the weekly US oil rig count, and secondly a decline in weekly US production. Lastly, as always keep abreast of changes to the ever volatile Geo-political issues which can add to volatility.

Dr. DiLiddo in his recent weekly essays has been keeping an eye on the Petroleum sector, even recommending in the February 6th essay that it’s time we start to buy Petroleum sector stocks. Let’s take a closer look at the key market drivers we reviewed last month and see if they support a long-term investable market rotation….or another short lived rally?

Crude Oil Market Update: Oil prices as measured by USO (US Oil Fund ETF as a proxy for West Texas Crude) reached a low of $16.68 on January 29, oil has increased by 17.6% based on a closing price of $19.62 on Feb.13th. In addition, RT which measures the changes in short-term momentum has moved sharply of the bottom since the low. With the RT moving averages all properly “sorted and aligned” this is a good indication that short-term momentum is turning bullish. So with the price rising, what factors are likely contributing to the change in sentiment?

Energy 1

Weekly Drilling Rig Count: As discussed last month, this data is available at and I encourage all Petroleum investors to watch the news every Friday morning for the update. The first major move in the oil price coincided with the rig count release on January 30, the day after the low.

Overall the total rig count has dropped a whopping 29% compared to the peak of 1609 rigs which occurred on October 10. More importantly the rig count in the key US shale oil plays (i.e. Permian, Eagle Ford, Bakken, Mississippian and Niobrara) are making up the bulk of the decline. Simply stated, with the drop in oil prices rendering most North American shale plays uneconomic, operators are shedding drilling rigs as fast as they can. This is STEP ONE in the oil price recovery….OPEC is getting the desired effect of their price cutting strategy. So what does this mean for North American production?

Energy 2

Weekly US Oil Production: Most shale plays exhibit high decline rates of over 70% in the first year. Combined with less drilling the cumulative production rates from the US shale plays may fall as fast as the share prices did! Falling US production will be STEP TWO in the determination of a more stable future for crude prices. But at least so far, production continues to increase despite the precipitous 30% decline in the number of active rigs.

Energy 3

Rotation within the Petroleum Sector : Lastly, we talked about how to use Delta searches to help identify changes in the relative performance of the industry groups within the Petroleum sector. By looking at the Petroleum sector performance graph, we see that the average price of the sector had a bullish cross-over above the 40-day simple moving average.

Energy 4

When the bearish sentiment is gripping the markets, you can expect Pipelines to outperform the E&P companies and services sector (i.e. Drilling, Field services and Mach/Equipment). When a bullish sentiment takes over, you will find the Producers are first to react followed by the services group. So let’s see what has happened in the last 20 days.

Bearish sentiment heading into the low (Jan16-Jan 29th) delta industry performance:
Energy 5

Bullish sentiment heading after putting in the low (Jan 29- Feb.13th) delta industry performance:
Energy 6

Notice the EXPLOSIVE move in the share price delta for the producers after crude put in the low! Furthermore the pipeline group is the worst performer in the sector as the large institutions start to rotate their energy positions out of the relative safety of the pipelines and into the momentum of the newly “Must-have” producing companies. Moving forward, watch for potential profit taking on some E&P companies with rotation into the Field Service, Drilling and Mach/Equipment sectors which have yet to fully participate in the rally.

May the trend by with you….

YOUR COMMENTS PLEASE: Are you buying petroleum stocks yet? What stocks are in your Watchlist?

Michael Wuetherick, P.Eng. Red Deer User Group Leader, VectorVest Canada January 15, 2015