After a rough go in 2014 and 2015, energy prices slowly began their upward ascent in 2016 after bottoming out under $30 per barrel early that year. Since then, Brent crude oil touched $70 before settling comfortably above the $60 mark this year.
Greatly aiding this recovery has been the commitment from OPEC and non-OPEC (lead by Russia) producers in the last year to cut oil inventories in the hopes that reducing supply would spur demand. That has indeed worked, but to be sure that oil is strong enough to stand on its own those producers have agreed to extend cuts throughout 2018. The decision of when to exit will be handled gingerly in order to assure the market doesn’t flip into a deficit too soon and that prices don’t heat up too quickly.
Not only have higher oil prices signaled a stronger global economy, but they have been great for energy companies. For the last two years, the S&P 500 Energy Sector has been leading in earnings and revenue growth due to the easier year-over-year comparisons. In 2017, that sector put up 260% profit growth, with the expectations for 2018 and 2019 consecutively dropping to 70% and 12%, respectively.
Energy is the sixth largest sector in the S&P 500 and makes up 15% of total market cap, but its outsized growth in the last two years has been a big contributor to historically high earnings growth, often artificially inflating how well the index as a whole is doing. More normalized estimates for energy have led to S&P 500 2018 earnings-per-share growth expectations of 16% and 2019 expectations of 10%.
A good leading indicator of how energy companies will perform is oil prices themselves, as well as weekly oil inventories. “Leading energy indicator” shows that during the last four years Estimize oil inventory estimates have lead similar inverse moves in the estimates for energy earnings. For example, when analysts move their oil inventory expectations upwards (in 2014 on this chart), they similarly revise their energy company estimates downward. Oil inventories report weekly, so there are several weeks of data available before energy companies report their quarterly numbers.
This year will be a good test for oil prices, which are often seen as a proxy for global growth. They must continue to hold current levels on their own, knowing that help from OPEC and Russia ceases at the end of the year. Of course, crude oil’s recovery is being reflected in retail fuel prices, which tick up as a result. Consumers have gotten used to ultra-low prices at the pump, but a gradual increase should not be a major concern, especially at a time when the job market is strong, wages are increasing and consumer sentiment is high.