Oil Bounce Could Lead To A Quick Pop For Producers

Sara Nunnally's picture

Tuesday, August 16, 2016 - 12:30pm

by Sara Nunnally

About two months ago, I showed you this chart:

It showed front-month oil future rebounding in a solid uptrend, but heading for a ceiling.

I warned that oil producers could see a short-term pop, but that it would be temporary.

I also said that higher oil prices would positively affect quarterly earnings reports. I was mostly right... Take a look.

This first snapshot is of Exxon Mobil's (NYSE: XOM) quarterly income:

This second snapshot is of ConocoPhillips' (NYSE: COP) income:

Both showed substantial growth in gross profits quarter over quarter. Year over year, XOM's revenues grew 18.45% in the quarter ending June 30, while COP revenues grew 11.17%.

COP released earnings on July 28 and XOM released earnings three days later. Since the earnings release, stock prices have climbed about 4.6% and 2.3% respectively, with some volatility. But I wasn't entirely right in my article...

You see, oil prices did some tricky dance moves since early June.

This chart shows the same trendlines from the ones I included in my chart back in early June. I've marked when my article hit the airwaves with a blue circle.

In that article, I said:

I've marked the shelf in red and extended the line to the current uptrend. The green lines mark the overall uptrend from the January lows. These trendlines converge to create a diamond that can "trap" movements, as price bounces back and forth like a pinball.

And that's exactly what happened. After topping out at nearly $53 a barrel, oil prices sort of went haywire, slipping below $40 a barrel in early August.

To add insult to injury. This oil price drop took energy stocks down, too.

This happened in a much faster timeframe than anticipated.

So although oil companies like XOM and COP did get a temporary pop in share prices as we predicted, that pop started from depressed prices from the slump in oil.

To be fair, I talked about a pop in prices after quarterly earnings, which we certainly got. But for investors making their moves based on this pop, oil prices are going to remain the main driver of share prices.

Oil prices have climbed about 6% over the past week or so, which is on trend with share price movements. And the big drop in oil prices since early June highs (oil has fallen 18.7% even including the recent pop higher), could have made more room for oil prices to tick up.

As we head towards Labor Day, this may happen and further push oil company share prices higher.

I still maintain that oil prices have created a ceiling at around $53 a barrel. This is just below the purported $55 a barrel that many U.S. producers use as a threshold to start ramping up production again.

But we could get a bit of an oil price surge over the next month...

Let's go back to the oil chart and take a look:

The purple line indicates a possible new level of support. This also happens to be just below the major 62.8% Fibonacci retracement line that traditionally predicts levels of support after a significant pullback.

If this bounce generates enough momentum, oil prices could rise back to the bottom red line at just above $48... though beware of some potential resistance at or around $46, where prices consolidated before they fell off a cliff.

From current prices, that's at least a 5% climb, which could also trickle into oil producers like XOM and COP.

XOM has been the better performer by far over the long haul (by nearly a factor of 7 if you look back far enough).

Risks To Consider: Risks abound in the oil sector. Volatile oil prices, sluggish economies, a tug-of-war between (over)supply and production and the continuing growth of alternative fuels even in the face of low oil prices means that we may not get to see a real bull market in oil for quite some time.

This scenario lends itself to capped upside potential and uncertain oil price movements.

In other words, it's not a market for unseasoned investors who can't afford to be wrong.

And to top it all off, the oil industry is facing a "wall of debt," as Bloomberg puts it. Oil companies owe a whopping $110 billion within the next five years. This will certainly push oil industry share prices far lower, particularly for smaller companies, in 2018 and beyond.

Action To Take: But in the meantime, big oil companies like XOM are riding this short pop in oil prices higher. With more room to climb before technical levels introduce resistance to higher price movements, both oil and oil producers should sweep higher.

My analysis shows room for a potential move higher in oil prices over the next month or more. That could be enough for short-term traders to walk away with a handy profit before oil prices hit the ceiling again.

Editor's Note: While oil prices may be set for a quick pop, oil is far from the only story in energy. On the same day that Elon Musk tweeted that Panasonic would be his only supplier of Model 3 cells, Panasonic added $800 million to its market value. Find out what Elon Musk is saying now to cause these three little-known stocks to skyrocket 10X by 2020. Full story here.

Sara Nunnally does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.