Ahead Of OPEC, An Analyst Is Bullish On Energy Stocks

Later this week, the Organization of Petroleum Exporting Countries and Russia meet in Vienna. The cartel and Russia, the largest non-OPEC oil producer, are expected to discuss potentially upping output to take advantage of higher prices.

Year-to-date, oil is one of the best-performing commodities and energy is the one of the top sectors in the S&P 500. The United States Oil Fund USO is up nearly 10 percent while the Energy Select Sector SPDR XLE is higher by 3.44 percent.

What Happened

OPEC and Russia recently discussed upping output under the guise of making up for supply shortfalls from Venezuela, among other oil-producing nations. For its part, the U.S. is pumping at near record levels, perhaps compelling OPEC to increase production.

“Initial reaction to the news led both oil prices and the energy sector to sell off the highs reached prior to the reported dialogue. However, the energy sector quickly bottomed and then started a move higher,” said CFRA Research Investment Strategist Lindsey Bell in a note out Tuesday. “In fact, the energy sector is only 3.3 percent off its May 21 high. Oil prices have been slower to bottom, though have recently begun to move higher as well.”

XLE, the largest exchange traded fund tracking the energy sector, resides about 6 percent below its 52-week high.

Why It's Important

To this point, OPEC and Russia have complied with previous output reduction accords and that compliance could give the countries some leeway to take a different approach later this month.

“The most recent reading by the International Energy Agency (IEA) showed OPEC had a compliance rating of 172 percent with the announced cuts, marking a record high,” said Bell. “Key to the impressive compliance is the decline in output from Venezuela, which has resulted from economic instability.”

Saudi Arabia, the largest OPEC producer, and Iraq have recently upped output to make up for the shortfalls created by Venezuela.

What's Next

It's likely OPEC and Russia will move to increase production following the upcoming meeting, but the degree to which output rises remains in question. Earnings estimates for the energy sector are surging and the group remains attractively valued.

“Valuation for the sector, on forward price-to-earnings (P/E) ratio, is 18.1x. Energy trades at a deep discount to the 29.2x P/E the sector averaged in 2017 and below the five-year average of 27.8x,” said Bell. “Given our outlook for oil prices to remain elevated amid supply constraints, solid demand and a reasonable valuation, we remain overweight the sector.”

CFRA has an Overweight rating on XLE.

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