Don’t Expect These Discounts To Last In Oil Prices (XLE, UCO, USO, CVX, XOM, COP)
Kent Moors: Markets declined significantly in the wake of last Tuesday’s Presidential election. In the two days that followed the S&P shed almost 3.6%.
But now the energy sector in general – and oil in particular – is poised for a major move up.
As I am writing this, six of the nine elements I regularly monitor to determine oil prices are pointing north.
The relationship between refinery margins (the difference between what it costs to produce oil products and the price that can be charged at the wholesale level – where the refiners make their profit) and inventory in gasoline are also indicating an oversold market, even without factoring in the East Coast double whammy of Hurricane Sandy and a Nor’easter.
The underlying dynamics, therefore, haven’t changed. If left to its own devices, oil prices should be moving up (and our profits right along with it).
So why the dip?
Where Oil Prices Go From Here
The first issue is short-term.
The aftermath of an election usually produces a downward pressure, regardless of who wins. The market bought into the election moving up smartly. It came out of the election moving in the other direction.
Nothing unusual there. The markets opened Wednesday morning with the election as history. That always occasions misgivings about what is coming next.
Yet cross currents over demand projections will be giving way to a more robust energy sector. This is not going to be a straight upward movement in prices. But those levels are currently depressed because of outside questions about overall economic prospects.
The oil market itself (and the energy sector as a whole will move essentially in the direction that its dominant component moves) has underlying dynamics that would dictate a crude price higher by about 15% at current levels.
But the outside “distractions” need to be weeded out first. Especially this time around.
There are two major elements preventing the energy sector from moving up.
I discussed both of these with my Energy Advantage and Energy Inner Circle subscribers yesterday, along with the way in which we have positioned both portfolios to profit from the current situation.
Here is the summary of what I told them. Two matters remain foremost in the mix, assuring that the next two months will be marked by considerable gyrations.
First, the clock is ticking in Washington on the “Fiscal Cliff.” Second, Mario Draghi, the head of the European Central Bank (ECB), has prompted new concerns over the Eurozone.
The massive spending cuts and tax hikes obliged by the “fiscal cliff” would certainly push the U.S. economy over the brink into a deep and prolonged recession. However, despite the low regard given to politicians in Washington, there are already indications they will reach an agreement before the end of this year.
This will not be an ultimate solution. Yes, Congress and the White House will compromise to kick the can down the street one more time. But that will be sufficient for our purposes. Expect a rally in energy when the central powers begin to telegraph the compromise.
The second problem – Europe – was actually the major reason why the markets tanked on Wednesday. Draghi said publically what a number of folks had been saying privately. European economies are slowing, with that slowing now beginning to hit the continental engine – Germany.
Draghi subsequently made additional comments on Thursday that tempered the impact somewhat. Yet, new riots in the streets of Athens following the controversial passage by parliament of an austerity package have once again put a visual on the situation. A truly incredible admission by the Greek government of an almost 25% official unemployment rate simply intensified the concern.
Well, here is what will happen with the ECB. The mechanisms are in place allowing the central bank to buy distressed paper, although there are still some domestic decisions that have to be made by EU governments. It also remains unclear when Spain will formally request a bailout.
These details will finalize.
The European capitals have no other option, despite the political unpleasantness of the requirements. Even then, the most important decision (setting up the structure to buy cross-border commercial bank paper) has already been made.
Europe will not regain its financial footing without a lender of last resort. The ECB has now assumed that position. Despite the disagreements resulting, the path is laid out to ease the situation.
Once again, as with the financial cliff in the states, we will experience a stop-gap measure, not an ultimate solution.
The market has been trading on emotional reading of headlines for some time. We have undergone two downward slides in oil prices that went well beyond anything the actual market justified, followed by recoveries just as quickly.
All in the last few months.
This will remain a volatile situation in both directions. The objective in developing and balancing an energy investment portfolio in such an environment is two-fold.
First, the stock selections need to reflect the tradeoffs in the sector itself. That is, not all reactions to market activity will move in the same direction. Second, there are ways to establish ceilings and floors on risk short of simply using puts and calls.
As we move through the current cycle of market instability, I’ll be providing some general suggestions in Oil & Energy Investoron how to design such a portfolio.
Related Tickers: SPDR Select Sector Fund (NYSEARCA:XLE), ProShares Ultra DJ-UBS Crude Oil (NYSEARCA:UCO), United States Oil Fund LP (NYSEARCA:USO), Chevron Corp.’s (NYSE:CVX), Exxon Mobil Corp. (NYSE:XOM), ConocoPhillips (NYSE:COP).
Dr. Kent F. Moors is an internationally recognized expert in global risk management, oil/natural gas policy and finance, cross-border capital flows, emerging market economic and fiscal development, political, financial and market risk assessment. He is the executive managing partner of Risk Management Associates International LLP (RMAI), a full-service, global-management-consulting and executive training firm. Moors has been an advisor to the highest levels of the U.S., Russian, Kazakh, Bahamian, Iraqi and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He’s served as a consultant to private companies, financial institutions and law firms in 25 countries and has appeared more than 1,400 times as a featured radio-and-television commentator in North America, Europe and Russia, appearing on ABC, BBC, Bloomberg TV, CBS, CNN, NBC, Russian RTV and regularly on Fox Business Network.
Moors is a contributing editor to the two current leading post-Soviet oil and natural gas publications (Russian Petroleum Investorand Caspian Investor), monthly digests in Middle Eastern and Eurasian market developments, as well as six previous analytical series targeting post-Soviet and emerging markets. He also directs WorldTrade Executive’s Russian and Caspian Basin Special Projects Division. The effort brings together specialists from North America, Europe, the former Soviet Union and Central Asia in an integrated electronic network allowing rapid response to global energy and financial developments.