Stock Market

Big Oil Stages a Comeback: Energy Stocks Lead the Charge in Early 2024 Rally

The stock market's landscape is perpetually dynamic, often led by big names in technology that command headlines and investors' attention. However, as 2024 unfolds, the energy sector, propelled by major oil companies, has started off with a roar that’s impossible to ignore. Following a lackluster performance that saw energy stocks concluding the previous year in negative territory, they have now surged to the forefront, outperforming their tech counterparts significantly.

As we delve into the specifics, the Energy Select Sector exchange-traded fund (XLE) has exhibited a remarkable growth spurt of over 13% since the beginning of January. This notable uptick starkly contrasts with the Nasdaq 100 Index, which, although healthy, shows a lesser gain of 8.7%. A pivotal factor contributing to this trend is the surge in oil prices, with West Texas Intermediate crude piercing through the $80 a barrel mark in mid-March for the first time since the previous November and showing perseverance at these levels.

Energy Sector Roars Back with a Strong March

"Most investors coming into 2024 weren't banking on a strong performance from the energy sector," said Leo Mariani, an analyst at Roth, during a conversation over the phone. Nevertheless, energy stocks have defied expectations and bounded forward, displaying an impressive resurgence in March.

This resurgence has not gone unnoticed, with the energy sector topping the performance charts of the S&P 500's eleven market sectors last month. It rose over 10%, outpacing the next closest sector, utilities, which posted a 6.3% increase, and considerably exceeding the broader index's 3.1% gain.

Investor attention is now turning to the eagerly anticipated OPEC oil-market monitoring meeting on April 3rd. The outcomes of this meeting will be pivotal in determining the future trajectory of the crude oil market and could either boost the ongoing rally or bring it to a pause.

An Eager Anticipation: The Binge-Worthy Beginning of Energy's Performance

Reflecting on the sector's performance, Dan Pickering, Chief Executive Officer of Pickering Energy Partners, compared the energy market of the first quarter to the opening scenes of a binge-worthy television series. "A significant number of people are barely into the second episode, trying to decide whether they commit to a full season of engagement — and the second quarter could very well be the decisive moment where one chooses to stay up all night to see what unfolds," he expressed.

What to Expect from OPEC

The upcoming OPEC+ meeting holds substantial interest for market observers and investors alike, with particular focus on whether the members will signal an intent to maintain the voluntary production cuts they've previously announced for the first half of the year.

"I believe the market is setting up an expectation for OPEC to continue its restraint," mentioned Ben Cook, portfolio manager at Hennessey Funds, during a telephone interview. He drew an analogy between the OPEC meeting and a Federal Reserve policy decision, emphasizing that while the anticipated outcome may be priced in, the nuances of the messaging will carry substantial weight.

The Russian Influence and Mid-Sized Producer Movement

Analysts from JPMorgan, led by Natasha Kaneva, project that Russia's decision to reduce production could elevate Brent crude prices to $100 a barrel within the current year. Trading currently in the high $80s, they predict prices could escalate to the $90s by May.

In response to this bullish outlook, some investors are directing their focus toward shares of mid-sized oil producers, which offer increased sensitivity to the rising commodity prices. A prime example is Diamondback Energy Inc., which saw a significant upsurge of 28% this year and exhibited a remarkable performance in March. Betting on firms with smaller production scale has its advantages, as Cole Smead, president of Smead Capital Management, suggests. "The most immediate impact on earnings estimates will be seen in the smaller producers, not the largest ones due to their lower operational costs," he explained. Smead's investment choices include companies like Apa Corp., Ovintiv Inc., and Canadian firms MEG Energy Corp. and Strathcona Resources Ltd.

The Promise in Refining Stocks

The refining space has garnered interest for even longer than oil companies, driven by the tightness in refined products markets and the escalating preciousness of capacity. The VanEck Oil Refiners ETF, for instance, has witnessed an increase of over 15% in the preceding five months, surpassing gains made by integrated giants like Exxon Mobil Corp. and Chevron Corp., as well as the actual uptick in crude prices.

Refining: The Underlying Bet

Strikes on Russian facilities by the Ukrainian military have further underscored the constrained nature of refining capacity, a factor catching the eye of investors looking to capitalize on the energy rally. Rebecca Babin, a senior energy trader at CIBC Private Wealth Group, weighed in on the issue: "We have spare capacity in crude oil, but the real bottleneck lies in refining capacity, pinched by events at the Red Sea and the ongoing situation with Russia, making the basis for the next chapter in the energy rally reside in refined products."

The Market Perspective and Analyst Expectations

Despite the recent enthusiasm, Wall Street harbors expectations of a decline in energy stock earnings for the current year, including an anticipated near-27% downturn in first-quarter profits, principally due to lower year-over-year oil prices. This projection stands as the largest expected downturn across any S&P 500 sector, as per Bloomberg Intelligence data.

However, with the evolving market situation, some analysts are reconsidering their stance. Mike Wilson, a US equity strategist at Morgan Stanley, recently adjusted his position on energy stocks to overweight. His rationale encompasses a variety of factors including rising oil prices, positively inflecting earnings revisions, strong market breadth, and attractive valuations. Energy valuations continue to persist at a historical discount compared to the S&P 500, allowing for a conceivable pathway of further dominance, as Wilson highlighted in a client note on March 25th.

Energy's valuation appeal is contributing to attracting new investors. "There's a quiet rally brewing within this sector, which is catching a few investors off guard," observed Jeremy McCrea, an analyst at BMO Capital Markets. He adds that those who were previously banking on an electricity-dominant future are now conceding to the possibility that oil and gas usage may extend further than initially anticipated.

Looking Ahead: The Oil and Gas Industry Prospects

The intriguing story of Big Oil's resurrection is just an early chapter in the financial narrative of 2024. With strategic meetings such as the OPEC oil-market monitoring convention on the horizon and global production decisions in play, investors remain on the edge, anticipating the potential turns in the plot. This year's market trend suggests that the energy sector's challenges and victories will be crucial to watch, as they could very well dictate investment strategies and market performances in the quarters to come.

In conclusion, the energy sector's performance is pivotal not just for its stakeholders but also for the global economic outlook. As geopolitical situations evolve, so do the prospects for Big Oil, and the market remains watchful, ready to adapt to the next twist in the tale of energy stocks.

©2024 Bloomberg L.P. - Source: Bloomberg