Why This Trade Still Makes The Most Sense
By Martin Tillier - Feb 20, 2015, 2:45 PM CST
The oil market’s reaction to news this week told us a lot, and confirmed what many of us have maintained all along. Oil’s collapse may have had elements of fear about growth to it but, at heart, it was all about supply. Oil was bumping along in a $53-$54 range despite further indications that a Greek exit from the EU was on the cards, and all of the negative implications that has for European, and therefore global, demand. Late in the afternoon, however, when the American Petroleum Institute reported a 14.3 million barrel increase in their estimate of U.S. crude inventories, traders were transported back to the end of last year as WTI crude did this.
After the market closed, futures briefly traded below $50 and a test of the mid-40s support looked extremely likely. Then, on Thursday, came the official number. While higher than most expected, that didn’t support the massive increase in stockpiles indicated by the API, and crude gained back some of the lost ground. Essentially ignoring a threat to global growth all day then turning tail at the possibility of a supply glut is a sure indication that it is domestic supply that has traders worried. The implication of higher stockpiles is that producers are still increasing production despite the lower price and that caused concern.
For those wondering whether now is the time to dip a toe back into the turbulent waters of energy stocks this is a clear sign that it is as good a time as any. Weekly numbers are notoriously…
The oil market’s reaction to news this week told us a lot, and confirmed what many of us have maintained all along. Oil’s collapse may have had elements of fear about growth to it but, at heart, it was all about supply. Oil was bumping along in a $53-$54 range despite further indications that a Greek exit from the EU was on the cards, and all of the negative implications that has for European, and therefore global, demand. Late in the afternoon, however, when the American Petroleum Institute reported a 14.3 million barrel increase in their estimate of U.S. crude inventories, traders were transported back to the end of last year as WTI crude did this.
After the market closed, futures briefly traded below $50 and a test of the mid-40s support looked extremely likely. Then, on Thursday, came the official number. While higher than most expected, that didn’t support the massive increase in stockpiles indicated by the API, and crude gained back some of the lost ground. Essentially ignoring a threat to global growth all day then turning tail at the possibility of a supply glut is a sure indication that it is domestic supply that has traders worried. The implication of higher stockpiles is that producers are still increasing production despite the lower price and that caused concern.
For those wondering whether now is the time to dip a toe back into the turbulent waters of energy stocks this is a clear sign that it is as good a time as any. Weekly numbers are notoriously unreliable, and any adjustment in production due to the lower price will take time. The basic laws of supply and demand, however, mean that it is a question of when, not whether that adjustment will come.
That drop in crude prices on Wednesday pushed stocks in the sector back towards their lows, allowing for some decent, risk-controlled trades. Back in December I suggested in these pages that if you believed that the big drop was all about U.S. supply, then taking the opportunity to load up on large, diversified multinational oil companies made sense. I hate to repeat myself, but now that there is a bottom to work with, the case for doing that is even more compelling.
Even after recovering during Thursday’s trading, Chevron (CVX) and Exxon Mobil (XOM) could be bought within 10 and 5 percent of their 52 week lows respectively, meaning that stop losses set to protect against another break lower would limit potential losses to that amount. In Chevron’s case the low of $98.88 was achieved on the 30th of, January and at the time of writing the stock was trading at around $108. Exxon bottomed out on the same day at $86.03 and is trading at $89.50.
Of course there is no guarantee that oil prices, and therefore CVX and XOM will climb again quickly, but it is only logical that at some point they will. I am not saying that we will get back to $100/barrel in a hurry either, but even a return to $60-$65 represents an increase of over 20 percent, and that is likely to be reflected in the stock of big oil. Whenever prices reverse, this week’s reaction to news in the oil market has made one thing clear…supply is the issue. That means that the previous lows, in the mid $40s in the case of WTI, around $100 for CVX, and $85 for XOM are likely to hold. In the meantime while you wait for Adam Smith’s “invisible hand” to guide the markets back to equilibrium, you pick up a dividend yield of over 3 percent from Exxon and close to 4 percent from Chevron. That and the knowledge that a stop loss is set should help your patience somewhat.
