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How To Play The Oil Price Rebound

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56b588005bbd2.imageIt’s not surprising that skepticism persists about signs of an oil industry rebound. After all, the sharp decline in oil prices since mid-2014 brought huge damage to a lot of industries and the stock market — particularly to investors in energy stocks. Indeed, the surprise 75% decline in oil has been a tough headwind to global growth.

So how real is the oil reversal? “Our assumption is that the recent price rebound is durable and mostly grounded in fundamentals,” says Lisa Shalett, chief of investment and portfolio strategies at Morgan Stanley Wealth Management, in a note to clients. The implications of stabilization at current levels are profound for inflation, she says, as well as for capital spending, global trade, inventories, S&P 500 profits and the emerging markets.

So her advice: “Consider opportunistically adding to energy-related securities on pullbacks,” mainly focusing on equities, master limited partnerships, and investment-grade and high-yield credit. So far this year, West Texas Intermediate crude oil has ranged between $38 and $48 a barrel. “If oil has in fact bottomed, the implications for investors may be significant, says Shalett.

The bears contend that the current rally is nothing more than a repeat of last spring’s rally when crude oil briefly ran up to $60 from $44 a barrel. They point out that oil remains oversupplied globally, and the rally only reflects in part the weakening U.S. dollar, which in turn is driven by a dovish Federal Reserve.

But some analysts believe that the overall global oil supply has finally gone negative.

Morgan Stanley’s Shalett notes that in the U.S., the source of much of he cycle’s marginal new production is the Baker Hughes Rig count, which is now at an all-time low, at 332, Since production tends to lag the rig count by six months, it suggests that the U.S. supply will contract at least through the end of 2016’s fourth quarter. And Shalett also points out that with the largest global exploration and production companies cutting capital spending by an average of 65%, and with banks and credit markets restricting new capital, and industry inventories up 15%, to 3.1 million barrels from a year ago, “it would appear unlikey that there will be a replay of last year’s oil-price head fake when suppliers kept pumping.”

And beyond the declines at U.S. producers, Shalett says non-OPEC suppliers should also drop from a reduction in North Sea and Russian output, and most recently a potential outage of as much as 1.6 million barrels per day due to wildfires near the Alberta, Canada oil fields.

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