The No.1 Contrarian Play In Oil
By Martin Tillier - Mar 25, 2017, 7:00 AM CDT
Regular readers of my ramblings will be aware that I don’t believe that this drop in oil will be of any long term significance. It is understandable, for sure, as the focus is on supply figures and inventories that indicate that U.S. shale producers are back in business and at least making up for the OPEC cuts. There are, however, three reasons that it is not a long term price adjustment.
Firstly, that shale production is, as we are already all too aware, extremely price sensitive. It has become the marginal source of oil and the cutoff for profitability, and therefore extraction, is starting to look like it is somewhere around $50. Secondly, as the focus of the market has been on supply there is still an improving outlook from the demand side of the equation, as tax cuts and stimulative infrastructure spending from the Trump administration are still on the cards. The prospect of cutting government revenue while launching a big infrastructure program is, I suspect, at least in part what is causing the third thing that limits the downside and makes for a bullish outlook for oil…the dollar has reversed course and is headed lower. Add all of those things up, then, and a pop back up above $52 looks likely in fairly short order.
(Click to enlarge)
The last week or so has seen a parade of oil talking heads on the business channels as the drop is analyzed and the fact that the vast majority of them agree that oil could fall a lot further only…
Regular readers of my ramblings will be aware that I don’t believe that this drop in oil will be of any long term significance. It is understandable, for sure, as the focus is on supply figures and inventories that indicate that U.S. shale producers are back in business and at least making up for the OPEC cuts. There are, however, three reasons that it is not a long term price adjustment.
Firstly, that shale production is, as we are already all too aware, extremely price sensitive. It has become the marginal source of oil and the cutoff for profitability, and therefore extraction, is starting to look like it is somewhere around $50. Secondly, as the focus of the market has been on supply there is still an improving outlook from the demand side of the equation, as tax cuts and stimulative infrastructure spending from the Trump administration are still on the cards. The prospect of cutting government revenue while launching a big infrastructure program is, I suspect, at least in part what is causing the third thing that limits the downside and makes for a bullish outlook for oil…the dollar has reversed course and is headed lower. Add all of those things up, then, and a pop back up above $52 looks likely in fairly short order.
(Click to enlarge)
The last week or so has seen a parade of oil talking heads on the business channels as the drop is analyzed and the fact that the vast majority of them agree that oil could fall a lot further only serves to convince me more that no such thing is about to happen. These are, after all, the same people that told us at $55 a few weeks ago that we were headed up over $60 or in some cases $70. So, for those of us who place stock in contrarian arguments such as this, what is the best way to play our beliefs?
The key here, as is often the case in trading and investing, is to understand that no matter how logical your analysis may be the market can act irrationally for an extended period of time. Given that, I would rather find something to invest in that would benefit from higher oil, but would have other supporting circumstances. Right now the out of favor, Transocean (RIG) seems to fit that bill.
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They are, as most of you are probably aware, a deep water specialist company that engages in E&P but also leases equipment and expertise in the area to others. You are probably also aware that since the Deepwater Horizon tragedy and oil’s collapse from triple digits deepwater drilling stocks have been slammed. That makes sense…deepwater drilling is an expensive form of oil recovery at the best of times, but with the relatively simple to work Gulf fields restricted after the disaster that dynamic has been exaggerated. That, however, is changing.
With the deluge of tweets, controversy and actual policy coming out of the White House in the last few weeks you could be forgiven if you missed it, but one of the early actions of the new administration has been to reopen the Gulf plays and offer leases on vast new tracts of undersea terrain. For a company like Transocean that derives part of their revenue from simply being recognized as one of the best in underwater operations that will be a boost to revenue and profit almost regardless of what happens to oil’s price.
That is what makes Transocean such a good way to play a belief in oil’s recovery. If that does happen then the stock will quickly recover the ground lost recently and $16 or so is easily reachable, but even if not the prospect of servicing work for others as the Gulf of Mexico re-opens will give the stock some support. Buying now, therefore with a stop just below the significant support level at around $11.70 looks like a smart thing to do.
