Wednesday, August 12, 2015

Continuing Oil Crash Points The Way To 2015's Energy Bargains

The second coming of 2015's oil bear market is going on right about now.  Plenty of bargain hunters who thought they bought into the bottom of the oil rout a few months ago are having buyer's remorse.  Watch Brent fall to 49 today and WTI fall to 43 as Saudi pumping cuts the legs out from under US shale producers.  Energy stocks can still get cheaper.  Finding the ones likely to survive this bear market takes serious sleuthing.

Forget about hunting junk bond bargains.  The oil services sector in the US is not done culling its own herd.  Junior producers are still pumping at full volume just to make it look like they can service their high-yield debt with cash flow.  That charade still has a few more months to run.  Any hedge funds or well-heeled private investors who think energy sector junk bonds have bottomed are welcome to try their luck.  Some people learn the hard way.

Other oil targets abound.  Owning BNO means betting on Brent crude futures and owning USO means betting on WTI crude futures.  Any compression between the Brent and WTI spot prices reduces the potential for arbitrage between these two ETFs.  More exotic bets like DBO and USL look like very complicated ways of leveraging a single commodity price.  Simple securities have fewer risks than complex ones.  The ETFs and other instruments betting on the magnitude of changes in oil prices have more moving parts than I can track.

The least complex ETF for exposure to the oil producing sector is probably XLE,  Holding a representative sample of large energy producers means each producer's operating costs are diversified away.  A simple equity ETF also has no internal leverage, so it does not expose its owners to exorbitant expenses or magnify their losses.  The P/E of 22 still looks high and resembles the broader equity market's high P/E after years of central bank stimulus.  A weakening sector should be priced at a bargain to the broader market, so XLE may have further to fall.

The price of oil itself may have further to fall.  Saudi Arabia is not reducing its production.  Storage is full in the US and shipping companies are seeing booming business in chartering tankers just for offshore storage.  Iran may have already begun selling the oil it has stored and will certainly increase production later in 2015 as the end of sanctions allow it to export.  I do not believe oil traders have priced in the effects of full production from Iran and other Middle Eastern countries that badly need hard currency.  More pain for the US oil sector means more bargain entry points for investors.

Full disclosure:  No positions in any securities mentioned.