The shares of most companies in Australia's energy sector are falling today and acting as a drag on the broader market upon fears that the recent rally may not be sustainable.
Investors have watched in awe as the oil price has surged higher in recent weeks. Of course, it remains well below the levels achieved in mid-2014 around US$110 a barrel or so, but at US$40.44 a barrel, it's still a lot better than the sub-US$30 it was fetching earlier in the year.
But as inspiring as it may have been for some investors, others – myself included – have remained sceptical that the gains would be maintained in the medium run. The fact is there is still an enormous oversupply of oil in the global marketplace right now, whereby stockpiles (which are sitting at their highest level since 1930, according to The Australian Financial Review) will need to fall considerably before a rally can be believed.
Its recent rebound appears to have been sparked by two major factors, including the possibility of a lift in demand from China based on its ambitious target to grow its economy by 6.5% annually over the next five years. Oil is usually required to help build an economy, so investors had been hopeful this would help even out the supply and demand imbalance.
An even bigger factor, however, was the speculation that the world's biggest producers could be meeting to agree to freeze output. A date of such a meeting remains uncertain, and it appears investors are becoming doubtful that an agreement will be reached – and if one is reached, whether it will make a significant difference.
Unfortunately for investors in the sector, analysts at Goldman Sachs think the rally is unsustainable as well. A rally would likely prompt further production, exacerbating the oversupply issue. So, according to CNBC, the Goldman analysts noted: "Energy needs lower prices to maintain financial stress to finish the rebalancing process; otherwise, an oil price rally will prove self-defeating as it did last spring."
Thankfully, it believes that a rebalance is likely in the latter half of this year.
Until then however, shares in the energy sector seem like a dangerous bet. Shares of companies like Woodside Petroleum Limited (ASX: WPL), Santos Ltd (ASX: STO) and BHP Billiton Limited (ASX: BHP) are all trading lower today, and could continue to do so if oil prices keep falling.
There could well come a time to buy their shares in the future, but I personally think it would be too risky to do so today. At the very least, investors should ensure they don't become overly exposed and that they maintain diversified portfolios at all times.
