The S&P/TSX Energy Index has jumped 10 per cent since Dec. 16 while crude oil prices have fallen another five per cent. For better or worse, investors in aggregate have decided enough is enough with selling in the sector, and have become bullish on the prospects for future returns in the oil patch.
SOURCE: Scott Barlow/Bloomberg
There is a loose consensus among energy experts that the West Texas Intermediate crude oil benchmark price will eventually settle in the $70 (U.S.) range. Any lower, and the majority of North American shale operations become unprofitable. When these properties stop producing, available supply falls, which helps support the commodity price.
To the extent that recent strength in Canadian energy stocks reflects the belief in an immediate recovery in the commodity price, it might be a mistake. In a recent column for Bloomberg, former Pacific Investment Management Co. LLC chief executive, and now chief economic advisor for PIMCO's parent company, Allianz SE, Mohamed El-Arian wrote:
"The world is experiencing much more than a temporary dip in oil prices. Because of a change in the supply model, this is a fundamental shift that will likely have long-lasting effects."
Mr. El-Erian's observation suggests that a recovery in oil prices is not imminent. For Canadian investors, this heightens the risk that the commodity price stays near current levels, and the recent 10 per cent rally in energy stocks will be erased.
Follow Scott Barlow on Twitter @SBarlow_ROB.