(September 20 – 18:10 ET) – The oil price picture suggests buying energy stocks and avoiding everything else says a new report from Jeffrey Rubin, chief economist at CIBC World Markets.
Rubin says the current oil price rise qualifies as an energy shock as big as the ones in 1973 and 1980. He says the most troubling quality of the current shock is that it isn’t caused by OPEC cutting production to artificially boost prices. “Instead of a temporary blip in prices, we seem to be on the threshold of a new era of rising energy prices.”
In this case, global demand is simply burning through all the available oil. He says that at current demand growth of 1.5% per year, the capacity to boost output will be exhausted within two years. “Beyond that point, demand must be rationed purely by price.”
Rubin doesn’t see relief from non-OPEC producers either, noting that the lack of supply increases elsewhere indicate that it may not be physically possible. “For the rest of the world, oil production may have already peaked and will decline steadily over time, leaving consumers increasingly dependent on a handful of OPEC producers.”
The real market threat from this is inflation. Rubin estimates that US$40 crude should push the headline U.S. CPI number well above 4%, which he projects, will cause the Fed to raise interest rates by 50 basis points over the next six months, with 25 bps likely before year-end. “Prospects for the red-hot Canadian market look suspect, particularly in light of less impressive earning gains ahead. By the fourth quarter, year-over-year earnings for the S&P/TSE60 should be down to single-digit territory, compared to the 60-90% gains seen in the first two quarters.”
In that context, Rubin says the best play is the oil and gas sector. Those stocks are priced based on a long-run spot price of under $25. “That misplacing of future cash flow leaves the TSE’s oil and gas index some 1,500 points shy of where it should be valued at current spot prices.”