Simply put, there is no support or interest in buying oil at this time, and that means oil prices could realistically hit $40.00 a barrel. Oil prices that low could cripple the global economy. Let me explain…
The Decline in Oil Prices
When the West Texas Intermediate (WTI) crude oil prices initially broke below $80.00, I was thinking maybe it was overdone. Then we witnessed a break below $70.00, followed by $60.00, and then $50.00. The failure of WTI oil prices to find any solid support suggests additional downside, as prices fell below $45.00 on Wednesday.
Chart courtesy of www.StockCharts.com
If you are thinking of buying on the weakness, forget it. Until we find a base for oil prices, energy stocks will likely head lower.
While the downside moves are related to supply and demand, the extreme selling is due to market speculation.
According to FactSet, the prospects for oil stocks are horrendous at this time and are expected to be the weakest among all S&P 500 sectors. The energy segment is expected to see earnings contract 17% for the fourth quarter of 2014, compared to an 8.1% decline as of September 30.
Weak Oil Prices Crippling Global Economy and U.S. Stock Market?
And now the World Bank has downgraded its gross domestic product (GDP) growth estimates for the global economy, including the eurozone and China, for this year. The U.S. appears to be an exception, with the World Bank expecting U.S. GDP to rise to 3.2% this year from 2.4% in 2014.
With the plummeting oil prices, many countries are producing oil at a loss or are squeezing tighter margins. Venezuela announced it would cut government spending by 20% due to weak oil prices, which is not good for the fragile economy that is dependent on oil revenues.
Amongst the oil producers, we are seeing massive spending cuts across the board. For example, Continental Resources, Inc. (NYSE/CLR) will be cutting its spending to $2.7 billion this year, down from the previous $4.6 billion and $5.2 billion. Likewise, Concho Resources Inc. (NYSE/CXO) slashed its capital expenditures by 33% this year.
These spending cuts will impact jobs and trickle down to the economy on the spending side. With millions working in the oil patch, this news isn’t good. Also, as oil workers spend less, it will impact other sectors, such as restaurant stocks, apparel companies, and manufacturers of other everyday items.
Is There an Investment Opportunity in Weak Oil Prices?
In my view, oil will continue to slide lower. As an investor, I would steer clear of energy stocks until we see support at the $40.00 level—and even then, I’d only consider investing via call options as a risk-managed trade.