Are The Bulls Returning To The Oil Market?

In the last several weeks, we've enjoyed a turnaround in oil stocks, accelerated by the two major storms in Texas and Florida.

And with a bit of a smile, we've seen more and more analysts convinced of the renaissance in oil prices that I advised you was coming months ago.

In my last column I pointed out Ed Morse of Citibank and Evan Calio of Morgan Stanley changing their bearish tune.

This week, we've seen a positive note on oil from Goldman Sachs, who only two weeks ago thought that the Harvey and Irma storms were going to kill demand and therefore be bearish for oil instead.

Goldman have been joined by the head commodity analyst for S+P/Dow Jones - who sees 80 oil on the horizon. Private trading house Trafigura also joined in abandoning the "lower for longer" idea for the current oil markets.

Finally, Moody's indicated that they believe shale oil companies can make no further progress at $50 oil and will need higher prices for any significant further increase in production - something I've been saying as well for months. Look at this move from Anadarko, now more concerned with cash flow than production increases. I am convinced this will become a major, very significant trend with the mini-majors for the rest of 2017 and into 2018. This trend makes the production projections of the EIA of another 1M barrels a day for US producers for 2018 downright silly.

But oil has taken a break this week from its steady climb, for two reasons I see:

First is the resuscitated dollar, seemingly coming back from the dead in the last week or so:

And second is the always quick on the draw hedge funds, who have been fast at turning positions around from being short and are adding long positions in the futures markets, particularly in distillate products, where a coming supply shortage seems all but inevitable this winter.

So, what do we do with the energy markets right now?

First, I think that many of our tried and true Permian oil players have had quite a run and deserve a break - I'd be looking for any dip to add to positions, but as for a place to get aggressive, this isn't the time.

Another idea is to move outside the E+P sector, seeking value in a lagging sub-sector of energy. I'm not convinced of the proper timing of oil services right now, even with the trend of increasing service prices going on. But perhaps, if you're looking to take some risk, there might be one to take - in offshore drilling, specifically Transocean (RIG).

My take on the oil renaissance as it applies to oil stocks has been to stick mostly with those you know will come out of the bust and into the boom in a healthy position, and not risk in those companies that could see $80 oil and still be overwhelmed with debt problems. This is why the choice of stocks to invest in today is so critical which I believe no shotgun energy ETF can supplant.

But if high-beta is your game, a bet on the survivability of Transocean could pay off very handsomely.

The first thing to realize is that Transocean, like the rest of off-shore, has still a very long and difficult road ahead. With $1.7b in debt repayment through 2019 and operating cash flow of less than $1.4b, RIG is destined to operate at a loss for the next two years at least. But with cash equivalents of $2.2b, it at least won't go out of business and can meet its obligations quite easily. They've just floated a $750m bond issue, which, at 7.5 percent, doesn't look too healthy for the company either.

None of this really matters - if we're trading it. Let's be honest: we don't care whether RIG actually makes it to profitability in 2022 or not. What we care about is whether they can be around long enough to generate some sweet stock gains, should oil really spike in the next year. With a share price that has gained 25 percent from its lows recently to trade around $10.50, the answer is - of course it can.

I have been of the belief that, like with E+P producers, there needed to be a number of offshore players declaring bankruptcy and thinning the herd of competition. This hasn't happened. Just as with the E+P players, the last year has been dominated more by restructurings and mergers (as with RIG itself acquiring Songa) and less with outright bankruptcy filings. This has made the prospects for those remaining in the sector less exciting than they might have been - but still very much worth considering.

In short, an investment in RIG at this point is one that envisions a move in oil above $75 in less than a year - which, if it happens, will generate a far better percentage return than with the safer E+P players. But the plan would be to take profits and disappear from the stock, still being unsure as to the company's ultimate health.