The increase in oil prices is just beginning – marketwatch q gas station


But I’m still bullish on energy companies in my stock letter, Brush Up on Stocks. It’s too early to sell. One reason is that most investors still don’t believe oil prices and energy stocks will hold, or are headed higher. This means energy stocks remain a kind of contrarian play, despite the recent gains. I can tell, in part, because of the skeptical coverage of energy names and the oil strength in major financial publications, which are often good contrarian indicators.

“Divergence between some of the best corporate sentiment we’ve seen in years versus low investor interest highlights a clear opportunity in energy equities,” says Morgan Stanley analyst Drew Venker. This suggests there’s more to come in the rally, he says.

Rising oil prices will help a lot. And that’ll be the trend. I don’t know where oil will trade tomorrow or next week, but here are six reasons why oil will continue higher in the medium term, driving energy stocks up, too. 1. Strong oil demand

The Organization of the Petroleum Exporting Countries (OPEC) cut daily production by 1.2 million barrels in 2016 and have stayed the course. Saudi Arabia needs oil revenue to fund domestic programs that help maintain the peace. For every extra dollar in oil prices, Saudi Arabia gets about $3.1 billion a year in extra revenue, according to Rapidan Energy Group. 3. Geopolitical risk

Energy investors wrote this off for years. But now, geopolitical risk is putting a bid under oil again due to rising tensions between Saudi Arabia and Israel, and Iran, in Syria and elsewhere. Two risks could drive up oil sharply in a heartbeat. Rebel groups have struck oil tankers in the Middle East in the past. They’re also targeting Saudi Arabian refining assets. Any successes on either front would roil energy prices. If Israel-Iran tensions escalate, Israel might strike Iran’s oil infrastructure, says Mike Breard, an energy analyst at Hodges Capital Management. That would have the same effect. Political tensions in Libya and Nigeria limit supply growth in those countries. Meanwhile, Venezuela is spiraling out of control and energy production there has fallen sharply. 4. Underinvestment in large projects

When oil prices tanked a few years ago, energy giants curtailed investment in their expensive, long-term projects, such as deep-sea production in the North Sea and Canadian oil sands. We’ve seen the largest capital spending slump in 20 years. Here’s the problem: The mega projects that are in production tend to naturally run dry. So there’s a shortfall developing in about half the world’s oil supply. It won’t be resolved quickly because these projects take years to bring online. That’s a problem for energy bears.

A big fear among investors is that U.S. shale producers will once again borrow and spend a lot to ramp up production, pushing down oil prices. But that’s not likely to happen. Many of these companies had near-death experiences because they were caught with too much debt when oil prices plunged a few years back. Others did “die,” in that they went bankrupt.

Survivors don’t want a repeat, so U.S. producers are promising they won’t borrow and spend too much again. They’re putting this message out because they want investors instead of traders in their stocks to reduce volatility. Capital discipline was a big theme in first-quarter earnings calls.

“Management teams are not showing an urgency to add rigs,” says Goldman Sachs analyst John Nelson. Meanwhile, there’s another challenge: Many U.S. producers face shortages of labor, pressure-pumping equipment and rail-and-truck capacity in their supply chains, says Bank of America Merrill Lynch energy strategist Francisco Blanch. 6. ‘Middle distillates’ demand

Ships are huge polluters because they use sulfur-heavy fuel oil. To clean up their act, the International Maritime Organization imposed regulations encouraging shippers to use cleaner fuel starting in 2020. This will increase demand for a type of oil called “middle distillates,” which will boost demand for overall crude oil. Morgan Stanley thinks this effect alone is enough to drive Brent crude oil

The bottom line in all of this: There’s a growing gap between demand and supply that needs to be filled, says Waghorn. OPEC could fill any near-term gap by reversing its 1.2 million barrel-a-day production cut. But that only covers about a year of demand growth. And OPEC only has about two or three million barrels a day of spare capacity. OPEC can only do so much. Be sure to look at the right oil price

Spot oil prices make the headlines. But those aren’t the prices that matter. Long term, energy stocks trade off the price of oil in the futures market a few years out, says Waghorn. Those forward oil prices haven’t moved up yet. The five-year forward price for West Texas Intermediate crude is still in the low-$50 range, while spot prices are around $71.

At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks. Brush has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.