A largely unanticipated cut in oil supplies will send prices for crude oil surging this year. And that will also help oil stocks break out of their extended period of underperformance.
Investors with an appetite for risk should consider buying the United States Brent Oil (BNO) - Get Report exchange-traded fund, which tracks the price of Brent crude oil. Or try investing in the Energy Select Sector SPDR ETF (XLE) - Get Report which tracks stocks of major oil producers.
The first part of the investment thesis comes down to Saudi Arabia, which was the world's second largest oil producer in 2017, according to the U.S. Energy Information Administration (EIA.)
"Saudi Arabia is now implementing a 'Saudi-first' oil policy, and the market should take seriously OPEC's pull-back on production to support prices after the declines late last year," writes Joe McMonigle, senior energy policy analyst at investment research firm Hedgeye Risk Management and former chief of staff at the Department of Energy.
In other words, Saudi Arabia wants higher oil prices to help maintain its oil-dependent economy and to make that happen it will slash oil production. Lower production tends to help lift oil prices.
As recently as Oct. 3, Brent crude oil fetched $86 a barrel before it fell to $66 recently, according to data from Bloomberg. But don't expect those lower prices to last long.
That's because the Saudi's have already begun reducing their pumping.
McMonigle points to the recent sharp reduction in output by the Kingdom from 10.6 million barrels a day in December to a likely 10 million last month. It could go even lower far faster than many anticipate.
"Saudi Energy Minister Khalid al-Falih recently said that Saudi oil exports would be significantly cut from 8.2 million [barrels per day] three months ago to 6.9 million [barrels per day] in March," McMonigle writes.
The figures McMonigle cites would indicate a 35% production cutback this month compared to December.
Steep supply reductions of that sort would ultimately lead to skyrocketing oil prices.
British Bank Barclays sees the price headed back to average $73 during the second quarter. However, it is worth noting that the oil market is particularly prone to price overshoots both on the upside and the downside. The record high price for Brent crude was $145 a barrel in July 2008, and it subsequently plummeted to less than $30 in January 2016, according to data from statistics website Trading Economics. On Monday, global oil prices extended their gains from their December lows.
In other words, that "average" price target from Barclays will likely be well short of the actual high in futures prices this year if history is any guide.
The other part of the equation for oil are the sanctions the Trump administration imposed on Iran which was meant to curtail the Islamic Republic's oil exports.
However, despite the tough talk, last year the White House issued waivers to some countries to let them continue buying oil from Iran.
Now there is a question about whether those waivers, which were temporary, will get renewed.
The answer is important because if the waivers don't get renewed then, that will mean another cut in the global oil supply, and hence even higher oil prices.
"We could see a great deal of volatility," says McMonigle.
In other words, a jump in prices to Barclay's $73 target could be just the beginning of a more substantial rally.
A Jump Start for the Oil Sector
The likely coming surge in oil prices could well help turn the tide on the energy stocks which have had a bad run for years on end, according to at least one measure.
"As a group, the energy sector has been horrific for years," says Rick Bensignor, president of financial consulting firm Bensingnor Investment Strategies.
He measures the performance of the group relative to the performance of the S&P 500 index, which tracks large-cap stocks. And that "relative performance" of the SPDR Energy Select Sector stocks has been in a downward trend since it last peaked in 2008. In simple terms, since 2008, energy stocks have underperformed the S&P 500.
But that could soon be over, says Bensignor.
"The sector's performance is starting to show potential downside exhaustion in terms of relative performance," he says. In other words, the selling of energy stocks by investors may be near its end, potentially paving the way for outperformance in coming years.
The author owns none of the securities mentioned in this story.