If you own a lot of energy stocks, you’re not going to like what I have to say, but I suggest you hear me out. I think we’re getting close to a significant downward reversal for crude oil, which obviously would not bode well for oil stocks.Heresy! How can oil prices fall with fighter jets screaming over Libya and pro-democracy uprisings in petroleum-producing countries like Yemen and Bahrain?
Well, think about the other side of the story. Why do you suppose crude has soared from $85 to $105 a barrel in the span of just a month? Isn’t it precisely because of all those suspenseful geopolitical events?
Let’s imagine for a moment, a world without Khadafi. It may not be that far off. With the colonel out the door, and a democratic Libyan government in place, I could easily envision a $20-plus drop in oil since Japanese energy demand has fallen off sharply in the wake of the earthquake/tsunami. If crude were to buckle, oil stocks, currently at the top of the standings for year-to-date gains, would take a header, too.
Technically, the oil market is ripe for some kind of “correction.” In recent weeks, the insiders of Big Oil — producers , refiners and other commercial interests — have been selling crude futures at a breakneck clip.
As of last week, the commercials were net short 310,000 contracts. Before this year, that figure had never exceeded 200,000. So the big boys are unloading at a rate far above normal. Do they know something the frantic “energy experts” on CBNC don’t?
I’m not advising you to dump all your oil stocks. However, I think it’s a good time to reassess your holdings and trim those of marginal quality.
One oil stock I recommend selling is Russia’s Lukoil (OTC: LUKOY). LUKOY has more than doubled from its lows during the October-November 2008 panic. Yet operations have stagnated, with production down almost 10% in the past four years. Thanks to the ebullient oil market, investors can now make a graceful exit.
In addition to LUKOY, I would sell Chesapeake Energy (NYSE: CHK), which has soared almost 60% since last November — an unsustainable move, in my judgment. However, I don’t recommend selling the conservatively managed, dividend-paying titans of the industry, such as Chevron (NYSE: CVX), ExxonMobil (NYSE: XOM) or Royal Dutch Shell (NYSE: RDSA).
These low-volatility stocks are unlikely to fall far if the price of crude backtracks $10 or even $20. Hold them. My sell advice is directed at the industry’s more speculative players.
Should you be concerned about your master-limited partnerships? Probably not. MLPs are primarily “toll takers,” collecting a fee for transporting, storing or processing fossil fuels. This business is largely insulated from fluctuations in energy prices.
Finally, peculators might consider shorting the United States Oil Trust (NYSE: USO) at $42.80 or higher. USO is an exchange-traded fund (ETF) that tracks the price of oil by investing in futures contracts and other derivatives. However, because of the costs built into the fund’s structure, it has badly lagged its benchmark (West Texas intermediate crude) for more than two years. That’s exactly what you’re looking for in a good short. Set a stop 10% above your entry point.
One last thing: I understand that some retail brokerage firms are reluctant to make USO shares available for short selling. If your broker is in that category, you might consider buying the U.S. Short Oil Fund (NYSE: DNO) at $36 or less.
However, this is really a second-best solution, because trading volume in DNO averages less than 1 million a day. I prefer more liquidity, particularly in a whippy market like oil.
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