The Craziness of the Oil Markets

Ok, so API oil inventory data came out last night, and things looked like crap.

WTI and Brent futures fell off a cliff post release, and I thought, “Well, the pain continues in the oil markets.”

Interestingly, as of this post, oil markets are up.

EIA data came in like this.

Things actually didn’t look as bad as people were pricing in.

 

So this is what’s crazy. Everyone and their grandma knows that oil will eventually go back up, but no one knows particularly WHEN. This begs the question, just how the hell do you make money in oil if you expect it to go back up?

 

Here are some of my thoughts:

1. Go long the low leveraged low cost E&P companies.

The problem with this trade is that most people are going this route so prices already reflect somewhat of a recovery. It reduces the reward for the given of risk taken, so I find this the least attractive option.

 

2. Go long oil ETF.

The problem with this trade is that the oil market is currently in contango (future prices > current prices), and buying the oil ETFs will mean that you would have to eat the roll cost (permanent impairment of capital). Not attractive.

 

3. Go long Russia.

This option isn’t so bad, and I would think a basket approach like RSX would be the best way to do it. This option also presents a problem in itself. Russia sanctions can pose either an attractive or unattractive idiosyncratic risk, so investors uncertain of geopolitics might shy away from this situation. My personal opinion is that things will get better in Syria and Ukraine, and the U.S. will lift the sanctions. Russian stocks will likely outperform everything else in this scenario.

 

4. Go long the E&Ps with just enough hair on them.

Companies like Encana, Bellatrix, Painted Pony and Gear have gotten absolutely crushed over the last year. I mean crushed. These are just some examples with great enough assets to warrant an acquirer lurking around, but hairy enough balance sheets to push investors away from buying them.

I have long thought that the best way to play this rebound is to find the best assets with just bad enough balance sheet to where they can live for 3 years +, but cheap enough to where the market is giving it to you for free.

The problem with this option is obviously that there is a strict time horizon (e.g. 3 years), so if the thesis that commodity prices will rebound in 3 years don’t pan out, well, you are shit out of luck.

 

Now I think there are a lot of varieties to play a rebound, but be warned, the oil market is crazy.

So if you dare to be in the #PainTrade, please share with me some of your thoughts on how you would play the rebound!

 

Until next time,

 

Pain out.

 

Disclosure: Long BXE, PPY.TO, GXE.TO