I'm always pleased to hear from Slope readers, but some really stand out. One gentleman wrote me a few days ago – he's an energy analyst based in Boston – and he had some interesting insights on the energy markets. His email was so good, I asked (and received) his permission to publish it here. If any of you want to contact this gentleman directly, drop me a line, and I'll pass your email on to him. Here is his post…………..
I trade energy stocks for a living after having covered the sector for 20 years on the buy and sell-side.
Oil and OIH now reside in an uncharted world. Specifically, SLB actually misses 1q08 EPS by 5% and the y/y was a paltry 10% (versus 63% y/y in 1q07, 82% in 1q06, 38% in 1q05 and 81% in 1q04); yet, the stock explodes higher yesterday propelling the move in OIH.
My fear in looking at your chart on BHI is that this stock is going back to $100.
Consider oil over the past five years. First driven by low inventories, myth now debunked; then lack of spare OPEC capacity, now debunked; then hurricane issues, debunked; then the Iranian issue, now debunked; then it was all about the dollar ? Now debunked. Dollar rallies sharply on Friday, gold goes down, but oil soars to new highs. Oil is on its own mission. The move higher sows the seed of its own destruction, but who knows where the point of pain exists.
Aside from housing, the single biggest reason to remain bearish is oil. The commodity may continue to explode higher until it crushes the economy and US, European and Japanese stock markets. WTI oil averaged $72 per barrel last year. This year could/will be $40 per barrel higher ? that?s $300 billion in higher oil costs alone to the US consumer, or almost 3x the so-called stimulus package.
The problem with shorting energy stocks is that fundamentals do favor the pure producers (not so the refiners or big oil).
I am glad we are able to make the connection as I have truly enjoyed your comments, which often exactly capture the mood of the markets.
The next several days are critical for oil and energy stocks. The May futures contract expires on Tuesday April 22. Crude needs a rest, but if it does not pull back at expiration, certain producing stocks are going to break-out to even higher highs. The reason is that the operating leverage for some of these companies is HUGE. The key is to focus on companies with high quality production assets, long reserve lives, AND low marginal tax rates. APA, CHK and OXY are three of the best examples. You have posted on APA, and the chart does look extended, but at $116 oil and $10 gas, the earnings and cash flow is there to back it up. I am not long APA at $140. I am quite long OXY and CHK. The former is perhaps the single best equity play on oil and the latter = one of the best plays on natural gas. I will explain more on these two names in a later missive.
The huge difference between energy, housing and tech ?bubbles? is that the energy companies actually have real EPS, cash flows and improvements in net asset value. The numbers at $100 + oil are staggering. For the industry, it is not about the % change in commodity price, it is about the absolute number.
I have been out of the OIH for the last year, after catching big runs in 2004 and 2005. The reason is that despite a great oil price, revenue and EPS growth RATE is slowing for the service sector, which I consider to be a key driver. I admit that I don?t understand the move in SLB on Friday, unless it was option expiration.
On the short side, the higher crude goes the worse it is for the refiners (VLO, SUN, MRO, TSO etc). Product demand in the US is negative, which has killed margins. Also, big oil is quite vulnerable at these levels. As a pair-trade to the producers, it looks worthwhile to be short XOM, with smaller shorts in BP, COP and CVX. The market does not yet know how bad refining earnings will be for the big boys until 1q08 EPS reports next week. Also, if crude going higher cracks the stock market, I project it will take down the big index names like XOM and CVX. The risk for me is that the reverse is also true. Lastly, if oil goes much higher, government is going to be forced to get involved. The window for me is that the so-called market pundits have not started picking up on how devastating the financial flows are for the global consumer at $120 oil.
The math is pretty easy because the US consumes 7.5 billion barrels of oil and oil products each year.
In sum, I have been involved in stocks for almost 30 years and this is the most dynamic, intellectually challenging period I have ever experienced. I will be back with more details on certain names, but in the mean-time, please take a look at the charts on OXY, CHK, XOM, COP and CVX. I value your insights on this sector.
