My Strategy for Uncertain Times in Energy
There has been no shortage of red ink in the market lately.
Paltry new jobs figures (69,000 new jobs, less than half of what was expected) have combined with the ongoing mess in Eurozone and lagging figures from China to sap investor confidence.
This latest action will further depress oil prices, as the rash of bad news translates into even more knee-jerk projections of reduced demand.
Of course, it's much too early to make such predictions based on the news, but the pundits do it all the time.
In any case, we are now in a downward movement that will end only when the market manipulators say so.
When this happens, individual investors always take it on the chin.
That's why I want to take a moment today to outline for you the strategy I use for my Energy Advantage and Energy Inner Circle subscribers.
Of course, if we could time the market, or invest in perfect hindsight, we wouldn't need an investment strategy.
But while some of the largest investment banks are getting it (very) wrong these days, crystal balls seem to be in short supply.
So what should we do?…
Well, there are three overriding considerations you must keep in mind when approaching the energy sector in an environment like this.
- First, know that this, too, shall pass. Take a deep breath and relax.
- Second, keep your power dry. There is no point in chasing uncertain shares in an uncertain market, simply because some talking head on TV says they are undervalued. In the current situation, almost 80% of the shares I follow are well below market value. However, until the market finds equilibrium (something it always does, by the way), the undervaluation means little. Nibble when you feel targets are cheap enough, but never go all in.
- The third point is the single most important thing to remember here. A situation like this one demands that you preserve your investment capital. Uncertainty is always the mother of discretion. The energy sector has been hit harder than the market as a whole for much of the last six weeks. That means you need to set up an exit strategy and stick to it.
Oil Price Forecast: Expect Oil Prices to End the Year Higher
Forecasts for oil prices in the second half of 2012 and on into 2013 are varied, but there's one point on which virtually all agree: Oil prices won't be going down.
One reason is that oil prices have already dropped substantially in recent weeks.
In fact, oil futures – as measured by the July New York Mercantile Exchange (NYMEX) contract for West Texas Intermediate (WTI) crude – closed below $90 per barrel last week, the lowest level for an active contract since October 2011. That's down $17 a barrel since the beginning of May.
Two factors have contributed to the decline in oil prices:
- A modest increase in U.S. crude supplies – up 3.8% in April from March levels and 1.5% from a year ago – primarily due to continued low demand as a result of the slower-than-expected economic recovery.
- Increasing strength in the U.S. dollar – the global pricing currency for crude oil – due to safe-haven buying in response to continued concerns over Eurozone instability.
Oil Prices Continue to Climb
Longer-term, however, both of those situations should stabilize, and then reverse – meaning current oil price levels will likely serve as a base for a rebound in the second half of the year, continuing into 2013.
Even so, the leading "official" sources for oil-price forecasts aren't projecting major spikes, either.
The U.S. Energy Information Association (EIA), in its most recent report issued May 8, predicted prices for WTI crude will average about $104 a barrel for the rest of the year, and that costs to refiners for all crude – domestic and imported – will average $110 a barrel.
The WTI number is down $2 a barrel from March estimates, but $9 a barrel higher than the 2011 average, while the refiners' cost figure is up $8 from 2011.
The American Petroleum Institute (API), a trade organization of more than 500 oil and natural gas companies, didn't issue price forecasts for crude in its most recent (May 18) report, but noted that increased domestic production, slightly higher crude oil stocks (374.8 million barrels) and lower imports in April should serve to keep prices stable to modestly higher going forward.
API also expressed optimism that rising crude production in North Dakota, which hit 551,000 barrels per day in March, and a possible reversal of President Obama's rejection of the Keystone Pipeline project could keep price hikes in check for the remainder of the year.
Such optimism wasn't nearly as prevalent among many private analysts and industry commentators.
Where Are Oil Prices Headed?
The uncertainty looming around worldwide economies sent oil prices sinking below $90 a barrel yesterday (Wednesday), a level not seen since October of last year.
Benchmark crude slid $1.95 Wednesday to finish the day at $89.90 per barrel.
The decline came on the heels of several weeks of slipping oil, sparked by a plethora of less than stellar economic reports. The concerning data mostly involved Europe's ongoing sovereign debt saga.
Oil gained 0.5% in early afternoon New York trading Thursday, but the reasons for the rally were unclear.
"You don't know if this is just a short-covering rally or the start of a more significant rally," Andy Lebow, an oil analyst with Jefferies, told The Wall Street Journal. Lebow said that progress in the talks between Iran and Western powers about Tehran's nuclear ambitions could have spurred Thursday's price reversal.
If the gain isn't maintained, however, prices could head closer to $85 a barrel.
The Top Five Eagle Ford Shale Oil Stocks
The shale oil boom is turning out to be even bigger than anyone predicted.
Recently Money Morning told you about the Bakken oil shale boom. The Eagle Ford shale oil formation in south Texas is nearly as large, and production there is ramping up rapidly.
Eagle Ford is among the largest U.S. shale oil deposits, with recoverable reserves estimated as high as 7 billion to 10 billion barrels.
But Eagle Ford is also "liquids-rich." That means it has a high concentration of oil versus gas — a major attraction at a time when oil prices are high and natural gas prices are at historic lows.
Many oil companies are eager to get in on the action at Eagle Ford, and expectations are running high.
Another oil company CEO, Bill Klesse of Valero Energy Corp. (NYSE: VLO), thinks Eagle Ford could have an impact even beyond bigger profits.
"It's going to back out sweet crude imports into the United States, and that's going to happen by 2014," Klesse predicted, speaking at Valero's annual meeting earlier this month.
Indeed, the statistics coming out surrounding the Eagle Ford shale oil operations are impressive.
Data from the Texas Railroad Commission, which regulates energy in the state, tells an amazing story. Shale oil production increased nearly seven-fold from 2010 to 2011, from an average of just less than 12,000 barrels a day to about 83,400 barrels a day.
And that could explode to 500,000 barrels a day by the end of 2012, Klesse said, with output expected to double to 1 million barrels a day "in the next few years."
Impact of Eagle Ford Shale Oil Underestimated
Eagle Ford has progressed so quickly that a forecast of its economic benefits became outdated almost as soon as it was issued last year.
A study by the Center for Community and Business Research at the University of Texas San Antonio's Institute for Economic Development in early 2011 projected the Eagle Ford formation would directly and indirectly contribute $21.5 billion and 68,000 full-time jobs to the 20-county South Texas region by 2020.
Last week UTSA released a follow-up study.
It found the Eagle Ford contributed $25 billion to the local economy in 2011 — $3.5 billion more than the 2020 projection.
The new UTSA study says Eagle Ford will pump about $62.3 billion into the local economy by 2021. The job creation number increased to nearly 117,000.
"We view the Eagle Ford activity as an economic opportunity of a lifetime," said Mario Hernandez, president of the San Antonio Economic Development Foundation. "The key goal is the increase in investment and jobs. And if the communities will partner with the private companies that are creating these jobs, it can be a win-win for everybody."
Growth that outruns forecasts is good news for investors. Money Morning has sorted through the many choices to zero in on five Eagle Ford shale oil stocks that could do particularly well:
Oil Prices and the Death of Greece
As the Eurozone continues to show weakness, events last weekend in Athens may accelerate the situation. The downward movement in oil prices this week in both London and on the NYMEX testified to the rising concern.
The aftermath of the Greek elections propelled the new radical left party SYRIZA into the limelight as the second strongest party in the country. Given the adamant refusal by SYRIZA leadership to accept bailout reforms, the party's new brokering position means the crisis will continue.
Bitter austerity measures await the formation of a coalition government, since no party received a majority of the seats in parliament from the vote. The coalition is supported by both the New Democracy and socialist PASOK parties, which have taken turns ruling Greece for nearly four decades.
But the surprise showing of SYRIZA has thrown the possibility of an accord into disarray.
At best, this means a further delay and likely a new election.
On the other hand, Greece has little time left. Any further delay in forming a government, with no guarantee that a very angry population will vote any differently the next time around, puts the next tranche of the European Union bailout package in jeopardy.
It is now more likely that Greece will leave (or be pushed out of) the Eurozone, casting a greater uncertainty on both the currency and the southern tier of countries still in the zone.
Spain is the current focus of concern, but Italy is also exhibiting renewed weakness.
Unlike Greece, Spain and Italy have debt problems that dwarf the ability of any Brussels-led support package. These economies are simply too large to be "rescued" from the outside.
The concerns over contagion, therefore, may actually expedite a Greek departure earlier than most thought possible.
It is true that any members leaving the Eurozone will have a negative effect upon currency strength and economic prospects. It is also unclear how the Greek departure will aid in shoring up either Spain or Italy. The problems in each of these economies are endemic; they are not primarily a result of "spillovers" from the situation in Greece.
All of which means, to borrow a phrase from former U.S. Secretary of Defense Donald Rumsfeld, there are a series of "known unknowns" now facing the EU. The credit and banking problems are essentially the "known" part of this equation. The extent of the fallout on the euro as a whole is the massive "unknown" flowing through the calculations.
This is accentuated by recent developments in the two major economies using the euro — Germany and France. No rescue package for any EU member is possible without the leadership of these two dominant European economies. To date, Paris has emphasized protecting its suspect banking sector, while Berlin has a strong political undercurrent demanding additional protection of German production and trade.
However, the recent French elections, in which a socialist has been elected president, and indications surfacing that the German economy may be facing a slowdown, will put continued support of a "bailout for austerity" approach to Greece in question.
Thus far, both major nations have led the EU-Greek approach, strongly arguing that the preservation of the euro demands it. The dramatic political events unfolding in Athens are rapidly undermining that support.
And this has impacted the price of oil.
High Oil Prices: The Truth About Obama's Misguided Witch Hunt
It has been less than a month since President Obama declared war on those evil oil speculators.
Standing in the Rose Garden on April 17th, the president laid out a $52 billion initiative to increase federal supervision of oil markets in an effort to crack down on oil price spikes.
At the time, oil was trading at $117.41 a barrel and $5 a gallon gas seemed all but inevitable.
According to the p resident, evil speculators had been working behind the scenes to screw the rest of us while engorging themselves on riches beyond our wildest dreams.
I said it then and I'll say it again…the president is chasing a ghost he'll never catch. Spending $52 billion on additional oversight is a complete waste of money and a misguided witch hunt.
I mean, think about it. If speculators are the same ones responsible for high oil prices, ask yourself why they're the ones getting raked over the coals these days as oil prices fall.
The short version: It's because speculators don't control oil prices and never have.
The Real Culprits Behind High Oil Prices
Pricing inputs – for better or worse – are driven by geopolitics, supply constrictions, war, tyrants with spigots and buyers who will only purchase as long as the prices are low enough.
This is not complicated. Any time there are more buyers than sellers, prices go up. When there are more sellers than buyers, prices go down.
Whether or not what's happening now turns out to be short- term noise or a long- term trend remains to be seen.
As I noted in a widely read article on April 20th, legitimate speculation has a valuable and essential role in the markets. It's very different from the already illegal manipulation that the president seems to confuse with speculation.
Oil prices are driven by two groups of participants – hedgers and speculators.
The former are typically producers or suppliers with a vested interest in securing as high a price as possible for their output. They can also be manufacturers who depend on procuring as low a price as possible for their raw materials. Both parties are interested in delivery as a function of pricing.
Speculators don't care about delivery and, in fact, go to great lengths to avoid it.
They profit from price changes that would otherwise hold hedgers apart while also providing liquidity to other market participants.
Here's an example that may help bring this to life.
Nanotech Breakthrough Delivers "Cleaner" Oil
A recent nanotech breakthrough means we won't have to rely on wind and solar as the main ways to fuel the coming Green Economy – to drive our cars and trucks and planes and keep our factories running.
And that's a huge relief.
You see, there's a problem with "clean energy".
Nothing in the world today can compete with the power provided by oil.
At present, it only takes a few barrels of oil to match the power a big windmill or a massive array of solar panels can provide.
And efficiency is just one problem. Unlike oil, it's very difficult to store clean energy to use (after the sun goes down or when the wind refuses to blow).
On the other hand, drilling for oil poses big risks. We want to keep our land and water clean and need to protect ourselves from the huge damage oil spills do to the environment.
Those safeguards, however, raise the cost of drilling and the price you pay at the pump. But what if you could drill for oil without concern for spills?
It would provide a boon to the entire U.S. economy and reduce our need for oil imports. We could save billions a year at the pump, lower the cost of making U.S. products, and create millions of jobs in the process.
No doubt, that would be a game changer…
That's why I'm happy to report that researchers recently invented tiny sponges that can soak up huge amounts of oil.
I predict that, in as little as a decade, these "nanosponges" will help the U.S. become more energy independent.
Too bad clean-up crews didn't have these two years ago to soak up the 200 million gallons of oil BP spilled in the Gulf of Mexico.
That was a big job, but these tiny new sponges – much smaller than a single human hair – could have handled it. In fact, their miniscule size is what gives these sponges their huge advantage. It's hard to imagine making sponges any smaller. After all, you can't see them individually without the aid of a powerful microscope.
Yet they can soak up many times their own mass… It's almost like being able to drain a swimming pool with an ordinary kitchen sponge.
Not only that, these sponges resist damage. You can actually abuse them without the material breaking down. Consider that a team of researches "squeezed" the sponges 10,000 times in the lab and found that they remained elastic and ready for use.
Oil and Gas Companies: What this EPA Official Doesn't Understand
Government bureaucrats really need to stop talking when there's a camera present; otherwise, they might just get caught telling the truth about their agenda when the tape resurfaces.
Enter Dr. Alfredo Armendariz, the U.S. Environmental Protection Agency (EPA) regional administrator for Region 6, a region that oversees environmental regulations for energy companies in Louisiana, Arkansas, New Mexico, Texas, and Oklahoma.
Turns out, Armendariz doesn't like oil and gas shale production, and he's quite the history buff.
Joel Gehrke in Washington explains:
"Al Armendariz, a regional administrator for the Environmental Protection Agency, explained in 2010 that he understands the EPA policy to be to "crucify" a few oil and gas companies to get the rest of the industry to comply with the laws.
"I was in a meeting once and I gave an analogy to my staff about my philosophy of enforcement," Armendariz said during a meeting in 2010. "It's kind of like how the Romans used to conquer little villages in the Mediterranean: they'd go into little Turkish towns somewhere, they'd find the first five guys they'd run into, and they'd crucify them and then, you know, that town was really easy to manage over the next few years."
Armendariz said that by finding companies that are "not compliant with the law and you make examples of them," the EPA could maximize its enforcement capability with limited resources. He added that "fines can get very high very quickly, and that's what these companies respond to.""
Let's forget the reference to killing dissidents for a second. That's a whole different therapy session.
There are a few important points that need to be addressed about this sort of rhetoric.
ExxonMobil (NYSE: XOM) Earnings Miss – But Investors Should Stay Put
Steve Schaefer at Forbes runs down the numbers:
"The energy giant recorded earnings of $9.5 billion, or $2.00 per share. Those figures were down 11% and 7%, respectively, from the first quarter of 2011, and earnings per share were below the $2.09 analyst consensus. Revenue of $124.1 billion was up 8.8% from a year ago, but just shy of the $124.8 billion expected.
Earnings in Exxon's upstream, or exploration and production, fell 10.1% from a year ago, to $7.8 billion, while downstream earning, which include refining, were up 44% from the prior year to $1.6 billion, thanks largely to gains from asset sales and improvements in volume and mix."
This earnings miss is the least of Exxon's short-term worries as we head into the summer months and the election heats up. There are a lot of problems for the company to overcome all at once – but it shouldn't send ExxonMobil investors headed for the exits.
How to Profit from High Crude Oil Prices
Despite a recent price pullback, my "oil constriction" approach for how to profit from high crude oil prices has not gone away.
In fact, it is right on track.
But we need to remember that the constriction in oil availability will not hit all oil sector shares the same way.
There are four overriding elements in what is coming.
1) Crude Oil and Gas Prices on the Rise
The markets have witnessed a rise in both crude oil and gasoline prices – West Texas Intermediate (WTI) prices are up 37% since Oct. 4, while RBOB (the gasoline futures contract traded on NYMEX) is up 29% since Nov. 25.
The constriction, however, is not simply reflected in the price.
We have a very different dynamic underway than the one experienced in 2008. Three years ago, it was a speculatively driven rise in oil prices that came crashing down when an outside crisis hit (the subprime mortgage mess and the corresponding credit freeze).
This time around, the constriction results from the rapid decline in prices from the third quarter of 2008 through a sluggish leveling-off through the fourth quarter in 2009. This period produced a significant cutback in new drilling.
Consider this: The top 15 oil producers in the world have replaced barely 70% of the extractable reserves they extracted over the past three years.
With conventional production, therefore, the constriction is already in place.
However, we have moved quickly into accelerating unconventional oil production.
That is element number two.