Oil Stocks Going Too High Too Soon

The chorus has become deafening: The International Energy Agency (IEA) has predicted a full 'rebalancing' of the oil market by late 2017, with OPEC joining in on that timetable Thursday. Our own Energy Information Agency (EIA) has gone even more aggressive, expecting a cross of the global supply/demand lines later this year and agreeing with the timeline that I laid out in my book more than a year ago.

The markets, as always an 'anticipatory' instrument, are responding by ratcheting up the prices of oil stocks, sometimes to levels that corresponded to oil trading more than $15 higher than current levels: EOG Resources (EOG) is near $80, Devon (DVN) at $35, Hess (HES) above $60 - all prices seen in late November/early December of 2015, when oil was hovering nearer to $60 a barrel.

As happy as I could be to see (some perhaps) premature profits on many of my long-term oil positions, I'm also wary: It is entirely clear to me that our oil stocks are getting out too far on their skis too soon, and even though I believe that oil could easily run towards $50 a barrel without taking a break, I don't believe the oil stocks should or will react more positively to an even more extended $5 a barrel rally.

Some analysts are seeing it similarly, even if they were late to this 'energy renaissance' 'sector rollover' 'short covering' party - or whatever name you'd like to put on it. Deutsche Bank, for example, has recently downgraded EOG, citing simply that at this point in the cycle, there were better values to be had.

I have to agree.

When the oil market was completely on the skids, making new lows under $30 and testing our resolve to continue to average into oil stocks, we did what our brains and insight told us to do - find the best quality shale players that were unimpeachable even through a year or more of prices below $40. That's where we found EOG and Chevron (CVX) and Cimarex (XEC). We mostly ignored anything but the best - those mostly solid E+P's that had warts on the balance sheet or excess exposure to natural gas or a suspicion of a dividend cut or bond downgrade were shunned. It is precisely these names that have delivered even juicier returns in the sector rally we've seen: Devon, from a low of under $20 is now near $35, Apache (APA) has gone from near $35 to $55, Continental (CLR) has moved from $20 to near $40 (!) and there's our beloved Hess.

These are the stocks we must center on now.

Our long-term plays are in place - or should be - and should remain untouched. The next drift down in oil stocks should not be used to add again to those, but instead used to add a little more beta on the ones that are clearly now far, far too ahead of themselves not to take another significant dip down.

So even if they're not the strongest players in the game, I'm going to key on those - many of which I've mentioned to you to keep an eye on and several we've traded successfully already: Pioneer Natural Resources (PXD), Continental, Devon and Hess.

A huge overhang of stockpiles still limits the upside in oil. This year's million barrel a day drop in U.S. onshore production will be offset by still increasing production in the Gulf of Mexico. Iran remains the wildcard in OPEC supplies and Saudi Arabia is threatening another 1.5m barrels a day of production (even if I think they can't manage it). In short, I think there is little chance that oil, and oil stocks, won't take another move downward - and a significant one.

Be ready for it - and buy some of our "B-players". They're poised to deliver some outstanding mid-term profits.