From BlackRock: A recent drop in energy-related assets appears overdone given our outlook for oil prices, creating opportunities in selected energy equities and credit. Richard Turnill explains, with the help of this week’s chart.

A recent drop in energy-related assets looks to be overdone. We believe this creates opportunities in selected energy equities and credit—even as we see oil prices trading mostly sideways in the near term. This week’s chart helps explain why.

Oil prices fell this month after trading in a tight range in early 2017. Concerns about industry oversupply led to the unwinding of record levels of speculative bets that crude prices would rise further. Energy stocks, however, appear to be pricing in too much pessimism. See the recently increasing performance gap between oil and global energy stocks above.

In a range-bound world

Demand and supply conditions supported oil prices earlier this year. Speculative trades in futures markets also contributed to crude’s rise on expectations the Organization of Petroleum Exporting Countries (OPEC) and non-OPEC countries would implement agreed-upon production cuts. Nervousness about record levels of such positions, rising U.S. supply and growing doubts about production-cut compliance sparked oil’s recent price drop. Further unwinding could pressure prices further in the short term.

Oil prices are hard to predict, as production cuts hinge on an uncertain political environment. We see oil trading mostly sideways over the next three months. OPEC members have shown discipline in cutting oil production, and U.S. inventory growth should soon stabilize as oil refiners increase purchases. Global demand is also likely to rise amid reflation.

Energy stocks appear to reflect a more bearish price outlook. This creates opportunities. We like U.S. shale companies, amid cost cuts, improving technologies and the prospects of looser regulation. We also see value in the diversification offered by integrated-energy firms, including relatively cheap European oil majors. High yield energy bonds offer slightly better value after a recent selloff. We prefer credits of exploration companies due to attractive yields and balance sheet discipline. Read more market insights in my Weekly Commentary.

The Energy Select Sector SPDR ETF (NYSE:XLE) rose $0.22 (+0.32%) in premarket trading Wednesday. Year-to-date, XLE has declined -8.11%, versus a 5.27% rise in the benchmark S&P 500 index during the same period.

XLE currently has an ETF Daily News SMART Grade of C (Neutral), and is ranked #15 of 38 ETFs in the Energy Equities ETFs category.

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Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

This article is brought to you courtesy of BlackRock.

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