Reflecting On The Oil Rally

A mélange of topics to be covered this week in the column, I cannot pick one that is more valuable than the other, so I'll try to touch upon them all - forgive the necessary superficial treatment:

We've been frankly awesome in some macro predictions about oil and oil stocks in the last several months and are really beginning to reap the rewards of those insights. We believed we'd see upwards of $75 oil this year, a prediction we're already seeing in Brent oil in April, all while the bank analysts have only slowly raised targets from well under $55 - not just for this year, but NEXT year as well:

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We've looked at the massive disconnect between oil prices and the prices of underlying oil stocks and have sent out a few buy signals for this tremendous opportunity - several of our favorites have registered massive gains in the last two weeks after that call.

Now quarterly reports are starting to roll in, on Thursday morning from Total (TOT), Shell (RDS.A) and Conoco-Philips (COP). What we can say from these few is that the advice we gave towards looking at the oil majors has been borne out again from these few quarterlies - Shareholders are no longer looking to reward a mere increase in production but need it to be in line with cash flow. Outspend your incoming cash flow on Capex and you will get punished; Exxon's performance has been the most obvious proof of this in recent months. In addition, shareholders want to see value restored to shares at a quicker rate, meaning an increase in dividends and commitments to share buybacks - Exxon again misstepped here, adding to their woes (although clearly at $70 a share, XOM was too cheap).

Further, we've seen similar performance based on these criteria play out in the mini-majors and independent shale players. On the plus side of a fast turn to efficiencies being rewarded we have Anadarko (APC) and Hess (HES) as examples, Concho (CXO) and Cimarex (XEC) as examples on the down side. Keep this forefront in your mind as you assess the coming reports this week.

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The speculative run into oil futures continues - and it has become a bit of a worrying trend for further gains at this point. It's not that I get easily unnerved about homogeneous positioning with speculators; since the end of the proprietary bank desk trading futures, the markets have been dominated by algorithmic momentum programs, so naturally you're going to see bigger swings to one side of the trade from the specs than ever before. But - the dangers remain in the possible reaction to an oil price that even momentarily comes off the rails. If, for example, Trump were to decide to stay in the Iran deal come May 15, that would put an unexpected negative (if short-term) pressure on oil prices. With speculators all long and chasing momentum, that could lead to a very violent downwards move in the price of oil - far more than the mere lack of new Iranian sanctions being discussed would normally have.

In short, the historically high number of speculative long positions in oil is NOT a reason to be short oil, but it IS a reason to be worried that an unexpected downdraft in the oil price is more likely to be a larger one; ie: ten dollars instead of three.

Finally, for those who have amassed some nice profits from taking our recommendations a few weeks ago and buying oil stocks - I would take the opportunity this week to cut some positions ahead of the Iran decision and again reiterate the opportunity forming in natural gas. I have described this in fuller detail in other columns, but again to be brief - we took advantage of a disconnect between oil prices and the prices of oil stocks. But that disconnect is even more pronounced between oil and natural gas prices. Further, indications about that natural gas is forming a long-term bottom. That will be the next frontier for us.

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Have a great weekend.