Most investors are no doubt happy to have seen the end of 2008—the worst year for the major market averages since 1937. Energy-related names were no exception to that rule. The Philadelphia Oil Services Index fell nearly 60% and the S&P 500 Energy Index was off 35%, while the S&P 500 was down 37.
But the long-term outlook for the energy sector remains bright. Short-term slowdown aside, strong economic growth in developing markets will continue to power strong demand growth in coming years. I maintain my forecast that oil will top USD100 a barrel once again in 2010.
Even better, there are signs the broader market and major energy indexes are approaching a key low, setting up for a major rally that will kickoff no later than mid-2009. We're already seeing a marked improvement in performance in the past few weeks, particularly for our three key themes for the New Year: high income potential; natural gas over oil; and integrated Super Oils.
It appears we did find the low USD30s in December; crude is now bumping up against the psychologically key USD50 level. The focus of the oil market throughout the back half of 2008 was demand and the impact of the global slowdown. I'm now starting to see a subtle shift toward closer scrutiny of the supply side of the equation.
Moreover, OPEC's supply cuts are finally beginning to take hold. Based on a late-December release, it appears the United Arab Emirates (UAE) is reducing output in line with agreed OPEC quota reductions. There are also growing rumors that Iran and Kuwait have informed certain customers to expect lower crude oil shipments, a sign these countries are also complying. I expect better-than-normal compliance with recent reductions because producing countries are truly scared by current depressed oil prices.
We're seeing tentative signs of a moderation in U.S. crude oil demand, figures for which were actually reasonably strong a year ago, so this suggests some real change in patterns of consumer behavior. U.S. retail gasoline prices have plummeted at the fastest pace in history, falling from above USD4 a gallon in mid-summer to about USD1.74 as of the most recent data. If the pattern continues, it's a sign this decline in price is encouraging crude oil consumption on the margin.
Supply factors, growing geopolitical tensions in the Middle East, and some tentative signs of a creep-back in demand have put a floor under prices around the USD30 area. Oil prices will likely carve out a volatile trading range over the next few months and begin to rally more aggressively alongside the S&P 500 later in the year. Oil inventories remain healthy in the U.S., and weak demand will remain a headwind for at least the next three to six months.