Monday, July 22, 2013

Equity markets are discounting the rally in crude oil

Energy shares have underperformed the broader market starting in April when crude oil prices touched the lows for the year. Stock valuations clearly responded to the downside. On the up-side however, in spite of the recent sharp rally in crude (see discussion), energy shares continue to lag.

Source: Ycharts

Equity markets are not convinced by the recent spike in oil prices and view it as temporary. The US government economists seem to agree. The recent projection of average cash prices for 2014 puts Brent forecast 9% below the current level while WTI is predicted to be almost 15% below where it currently trades.

Source: EIA

The general consensus seems to be that unless we have further unrest in the Middle East or an unlikely event of materially improving economic fundamentals globally, prices should decline. Of course the question remains: How long should oil prices stay elevated relative to forecasts before energy shares begin to outperform?
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