How To Trade The Oil Major Exodus From Russia

Earlier this week, crude broke through the $100 level. It did so without really so much as a pause on a day when futures posted a massive 13.8% gain. If you missed that move or, like me, you simply got it wrong, you will be looking around for opportunities from here. It goes without saying that it is a difficult task at this point. Everything has moved already, and it is hard to say that crude, even up here, is overreacting to the situation given the possibility of an embargo on a producer as important to global supply as Russia. Where there has possibly been some overreaction that could result in an opportunity, though, is in the multinational, integrated firms that have, or have had, exposure to Russia that have dropped.

Not all of those stocks are about to bounce, though. You need to exercise some selectivity when looking for trades. Or, if you are a bit gun shy after getting the big move wrong as I am, you may want to consider a somewhat more complex paired trade, one that by definition includes a natural hedge. It relies on the difference in impact of withdrawing from Russia for different companies and how the market has reacted as they have announced plans to do that.

BP (BP), for example, has lost 18% from its pre-crisis high but may drop even further.

That is clear when you consider that estimates to the hit BP will take run as high as $25 billion and the company has a market cap of around $90 billion. On the other side of the ledger, the jump in oil prices will obviously help the rest of the company’s business but, going forward, they have lost nearly half of their oil and gas reserves. On balance, 18% looks like an underreaction.

By contrast, a company like Shell (SHEL), whose stock has also dropped, will not take a particularly large hit from all this. They have a few high-profile investments in individual projects that they are pulling out of, but their overall exposure to Russia is much lower. Shell’s last annual report identified less than 5% of their global oil and gas production as coming from Russia and their stock has reflected that, falling by around the same amount from its close on the day before the invasion.

Meanwhile, oil has gained over 20% and natural gas over 7.5% in the same timespan which will have a positive impact on 95% of Shell’s production. Obviously, there are a few other things to take into account and the math is not quite that simple, but the minutia of the math is not the point. The simple fact is that SHEL has dropped by a percentage that reflects only the company’s direct hit without allowing for any positive influence from other factors, while BP has dropped more, but in percentage terms, reflected those positives and then some.

The idea, then, is to buy SHEL and sell BP. You can do that directly by going long SHEL and short BP stock, or through options by simultaneously buying close to the money calls on SHEL and puts on BP. However, you do it though, pairing the trade in this way means that you are taking a position purely on the spread between the two stocks. If oil drops and everything falls with it, or if it continues higher and everything jumps, you will make money on one side and lose on the other. You only make or lose money in total if the delta between the BP and SHEL changes. Given the way the stocks have reacted so far, there is a good chance that will happen.

I missed the big move up because I made a wrong call. That happens, though, and my trading style meant that I took a limited hit and am alive to trade another day. So, I won’t waste time crying over spilled milk, but will just move on to a paired trade with BP and SHEL that offers potential profit but with limited risk.