Beyond Crude Oil: A Long Term Play In Natural Gas

Last week, I talked about the illogicality of recent moves in crude, and there has been more of the same this week, if anything even more pronounced. I guess I should be used to markets behaving illogically after nearly four decades of working in and around them. In fact, I am not even sure if a counterintuitive move such as we saw this week in crude can be called illogical when it happens so frequently. Still, there are times when a move, particularly following a news or data release, puzzles or even shocks me. This Wednesday was a case in point.

I am sure that if you subscribed to a newsletter from Oilprice.com you are aware that Wednesday is a big day for oil traders. At 10:30 every Wednesday morning, the EIA releases their oil inventory report, data on supply and demand for domestic oil. Usually, the market reaction to the report is predictable enough. If inventories increase more than expected or decrease less than expected it indicates higher supply and/or lower demand than the market has priced in and crude drops. The opposite is also true, prices rise should storage numbers decrease more or increase more than expected. There are sometimes extenuating circumstances such as changes in gasoline supply and demand, but with those in mind, subsequent moves usually tend to make sense.

This week there was no excuse and no logic. Crude just did something weird.

The EIA numbers on Wednesday were about as bad as they could be. Going in, the market was expecting a small drawdown of crude inventories last week, but there was a build of over 15 million barrels. That is a massive miss. The gasoline numbers didn’t help, either, showing a 4.2-million-barrel build there.

Crude initially behaved, dropping below $45 from over $46 but then immediately gained all of that back, then soared to a high of $47.74 yesterday.

There were excuses, of course. There were attacks on two small Iraqi production sites, and there was the vaccine news, but neither of those really holds up to scrutiny. I mean, disruption in the Middle East is not really news, is it? And the vaccine has been anticipated and largely priced in for some time. Given that, jumping 5% after evidence of such a dramatic oversupply problem is just crazy.

Last week, I said that I was taking some profit on long positions in energy stocks and looking for opportunities to short crude but after this, I am giving up on even that. “Crazy crude” has finally beaten me, and I am retreating until it starts to make some sense.

Instead, I have been looking at Natural Gas and one interesting, long-term play stands out there.

ONEOK (OKE) is a natural gas-focused pipeline and storage operator. I started looking at them because I was looking for gas plays in general. After five waves in a down move and a bounce, natty looks like it will at least challenge $3 again soon and I was looking for ways to play that. OKE would be one, although the fact that they have existing, fixed-price contracts for their services makes them less sensitive to some to the commodity price.

As I looked, though, I became aware of something else that could give the stock major momentum.

When the Biden administration takes over next year, environmental regulation is likely to be one of their early areas of action and things like the Dakota Access Pipeline (DAP) project will be in immediate danger. That is an oil pipeline, so the connection to OKE is not immediately obvious. One could even argue, and some have, that if that project is scrapped, the resulting fall in oil output, and therefore probably gas production would hurt OKE.

There is, however, another way to look at this.

The abandonment of the DAP won’t change current output levels immediately but will result in a bottleneck for crude from the Bakken, the field that it serves. That will create a massive demand for pipelines and result in high prices for those able to service that demand. OKE has a large Liquified Natural Gas (LNG) pipeline that serves the same basic route as the DAP that could be repurposed to carry crude. Basically, as strange as it may seem, an attack on the DAP could prove to be extremely good for OKE.

In a week full of crazy stuff, when crude jumped after a terrible inventory report and stocks fell on the day after the first Covid vaccine was approved for use in the U.S., it kind of feels right to take a trade that, on the surface, looks crazy. Given the risk to the DAP, buying OKE fits that bill but this trade may well turn out to be crazy like a fox.