Weekly Energy Equities Review and Trading Plan for March 16-20
Mar 15, 2020 Trading Blog
I don’t know about you guys, but I slept 12 hours Friday night. That was the longest week I can remember in quite awhile. Five days of 3:50 am and stuck to the screen for 12 hours, and then stressing for the other 12. It was a great daytrading week (mostly IWM short scalps), but the short term gains weren’t enough to completely offset the losses in the longer term account, so the week was overall negative for me. But it could have been way worse. No personal coronavirus opinions in today’s post, I’ve simply come to the conclusion that the world is full of idiots, let’s just leave it at that.
The Trump SPR Plan
Not sure where to even start this weekend’s post, but I guess I’ll start with Trump’s SPR announcement and the resulting Friday price action. XOP was actually holding up pretty well midday in that 8.55 area and there was some accumulation going on which likely would have led to a bounce in the last hour anyway. The news just amplified that. I suspect that the run from 8.60 to 9.70 (and nearly 10 after hours) was mostly short covering. XOP traded most of the day within Thursday’s range and the entire breakout of that range was in the last 10 minutes. Without that news, I don’t think we would have had enough buying to break out of Thursday’s range. I have a feeling that there will be a big group of traders on Monday morning wanting a second chance at dumping into that Friday spike. Don’t be surprised to see an even bigger gap up Monday and then an all day fade back under 9.
The real problem with this big XOP move is the quality of the stocks causing the spike up. The components with the biggest gains were also the most likely to end up in bankruptcy at some point. OAS +170%, PDCE +145%, CHK +100%, WLL +73%, LPI +61%, RRC +36%. You get the picture of where most of the XOP gains came from. For example, in the XOP, RRC (+36%) is weighted 3.14% while XOM (+2.5%) is weighted 3.5%. Market cap on RRC is 500 million, while XOM is 157 BILLION. As I’ve pointed out many times before, when the trash companies are leading the XOP, that doesn’t usually lead to sustainable move. So, is a move in XOP caused by these little trash companies sustainable? Is the gain truly reflective of the sector itself? Will all these trash companies hold these size gains? Probably not. I don’t see many people being willing to pile into WLL after a 73% run up, same thoughts for the rest of the trash. It’s probably more reasonable to take a look at XLE and the majors for a more valid representation of what happened Friday.
So back to the cause of the big 15 minute green candle, Trump’s SPR comments. He said they were going to fill it to the top. There were NO details on this, and that presents several issues. I’m not hugely familiar with how the SPR works these days, but I do know there are different grades of oil in there, and it’s not the high API we produce domestically. It mostly holds oil that we don’t produce here, yet the latest order to fill states that we will fill it with “American made” oil. The SPR was created to stock up on the kind of oil that America was required to buy from other countries just in case they tried another oil embargo. We could ride out the embargo with the emergency oil until things got back to normal, and then we could continue our purchases from those foreign countries. But now we want to fill it with our own high API oil, which really doesn’t run that great in our refineries, which is why most of it is exported. We are storing something that we really can’t even use in an “emergency”. So this really isn’t for future emergency use, it’s to prop up E&P’s, therefore I think that oil will just get drained right back out and exported in the future. And that will cut into the future E&P direct exports, as well as increase supply.
I see a few problems with the SPR plan. First, it just creates more of the bad conduct that the market wants oil companies to correct. It just encourages them to continue producing at prices that aren’t profitable. Basically, they are just digging it out of the ground for a cost of $50, selling it to the government for $30 and the government puts it back into underground storage so they can dump it right back on the market later. Big funds aren’t going to buy the stocks until these structural operating problems are corrected. So while this might be a bandaid for prices in the short term, it doesn’t promote a larger scale turnaround in these companies or their stocks. It’s still the same old bad business model which funds aren’t going to be interested in buying again.
Second, and this is more of a long term issue, the government is going to fill the tanks to the top at $30. If oil prices ever get significantly above that $30, Trump will probably sell that oil to cap prices. He is always talking down oil price as a tax break for consumers. Now he has a magical lever to drop oil (and gasoline) prices anytime he wishes. While the short term support is helpful to shale, the longer term effects might not be. My thesis for buying some of these energy companies in the longer term account was that I think we are sowing the seeds of a future price spike. When projects are cancelled, production is cut and supplies dwindle, price starts to rally. You can’t just bring all that online quickly, and that produces a supply crunch. But now, even if that happens, all we have to do is dump oil out of the SPR (which ironically ends up being the same thing that Harold Hamm is now complaining that SA is doing) to resolve that supply crunch. Prices capped.
Lastly, and this is probably the most dangerous problem I see, I think this move by Trump is very shortsighted and just a slap in the face to SA, and more dangerously, Russia. It will only provoke them to take the next step against the US with more extreme tactics. With this move, we have now joined their game of price war chicken. My guess is that Putin will not negotiate until our SPR and other storage is full and overflowing, because you know what happens to prices when all the storage is full? Total collapse. When storage is full and we have to completely shut off the taps and turn out the lights, Putin can get anything he wants out of us. This latest SPR move just extends the price war game. Further, once the tanks are full and prices collapse, Trump will be sitting with a full tank of oil that could be worth as little as $10, and at some point we will have no choice but to sell out of our full tanks if we want to open up anymore storage space (either SPR, Cushing, etc). At that point, I’m sure SA and Russia (or someone else) will gladly take all this stored oil off our hands at $15, a nice loss for America. Putin doesn’t play the short game, he’s a long range thinker and I don’t think Trump fully appreciates that fact. All we have done is provide Putin encouragement to extend the game for a bigger reward. When all the storage is full, it’s game over for US oil.
In summary, even with all the negatives above, there’s really no guarantee that this SPR plan would even help anyway. The supply is only half the problem. Unfortunately, the demand is crashing faster than any reduction in supply addressed by this SPR plan. It’s a bandaid on a cut that probably needs stitches instead.
Overall Market SPY IWM
I think we have established a SPY short term bottom at 250. It definitely went further than the 271 I was looking for, but luckily it didn’t go as far as it could have to that December 2018 235 area. We should get a bounce next week, which could go as far as the 286-290 area. Once it makes that next bounce though, that’s when things are going to get really dangerous. When a bear market starts, the first fall isn’t the killer, most people hold everything in their 401k’s because that’s what they have been taught to do. In fact, the usual lesson they are taught is not only to hold, but to buy more at better prices. So while the first move down hurts, everyone still has hope and nobody is really devastated. It’s that second decline that’s the real soul crusher.
The key this week is to see how far this bounce goes. Once it tops out, then everyone in the market will be watching that 250 area. It’s obvious and there’s going to be a mountain of stops just under that level. Every nervous 401k holder will be watching the 250 break to make a sell, every new long made this week has their stop under 250 and every bear will be shorting the 250 breakdown, and all three of those groups could start the waterfall down. I’m not saying it’s going to happen, just pointing out how much fuel is there if that 250 level gets broken. Knowing this, the buyers have no real reason to step in quickly, rather they could all pullback and wait to see just how far it falls. With all those sellers and no buyers, we could easily be looking at SPY 200-210. Like I said, not predicting, just pointing out how dangerous the area could be, so protect yourself.
As usual, IWM is in worse shape than SPY. All the closings and travel restrictions here in the US are going to crush our domestic companies who depend on the US consumer. It’s the smaller businesses that won’t recover. The Apple’s of the world will be fine, but an IWM smallcap with a couple hundred employees could find itself bankrupt if this goes on for six months. IWM is down 35% in this correction and easily took out the Dec 2018 lows at 126, dropping as far as 110 and closing 119 on Friday. If you want to monitor the coronavirus effects on the US, watch the IWM rather than the SPY. The IWM also correlates very well to energy since both are heavily consumer dependent. Watch how the IWM handles that Dec 2018 low point of 125 on the bounce this week. I suspect it stops right on it before reversing and heading back down. Smallcap domestic companies are going to bear the brunt of the virus damage.
Energy Sector XLE XOP XOM CVX
It was a week of total destruction, starting with the huge Monday gap down on the OPEC/Russia price war, and things never got any better. I know it sounds like a broken record, but I don’t think we’ve seen the final lows. The OPEC/Russia supply fight will go on for a long while and the demand side of the equation isn’t going to get any better with the world cancelling more and more events every day. I think the demand effects are going to be worse than many are expecting. The entire country will be shut down by the end of next week as the Trump administration just can’t gamble at this point since they were so late in getting started. I’m betting that they err on the side of safety and go overboard with the isolation and closings.
I know in my own household my wife and daughter’s cars are both going to be parked for at least the next three weeks, and all of my wife’s business travel has been cancelled indefinitely. No oil and gas used here, and I’m guessing most households will be this way. But that’s not the most concerning part to me, what really concerns me is the long term isolation effect. You can’t just snap your fingers and return to how things used to be. This fear will linger for at least a year (and return for the 2020 fall flu season) and that will have a residual effect on demand for a longer period than most are expecting. If we have even a single coronavirus case this fall, then we go through this same song and dance again. Can’t put the genie back in the bottle.
So what to do with these energy stocks? Well, if you are already in, you just have to ride it out. I don’t think we are going to see any type of V bottom here. I think we probably end up seeing a long XOP consolidation in this 8-13 range for several months, with maybe the occasional exploration to the 15 area. It could morph into the perfect Wyckoff accumulation formation. I was definitely early in my long term account, but the larger positions of XOM 40.50, XLE 37.60 and XOP 12.67 aren’t totally out of reach on a nice bounce. The service positions of SLB 25.06 and HAL 13.57 will be losses, but hopefully small ones. The small EOG, PE and MTDR positions are toast LOL. If we got some crazy short covering bounce this week backed with a FED rate cut and some kind of extreme Congressional aid package, I wouldn’t hesitate to cut XLE, XOP and XOM breakeven or for small profits. I missed it, I was early and I never expected a 1987 crash type situation like we had this week. I don’t think anyone expected this. Sometimes if the market overreacts to a news event and gives you a chance to get out breakeven, you have to take it and start over. If this sector was the only thing down I wouldn’t think this way, but seeing some of the other deals out there in other sectors, if I could get out of these breakeven and transfer that money to better opportunities, I’d do it in a second. The opportunity cost on this trade has been worse than the actual dollar loss.
Individual Energy Stocks
XOM had a terrible day on Friday and it appears that there’s concern over the dividend. That’s the only thing that I can guess that’s causing the disconnect in XOM right now. It was barely green while XLE and CVX were both up 9%. It was the same weakness for BP and RDSA. The dividend majors are not in favor right now. If any of the majors cuts the dividend, the entire sector will tank even further, probably another 20%.
The service stocks were also relatively weak on Friday. Neither SLB or HAL really got much of a bounce on Friday afternoon. I can understand why the SPR bounce did more for the actual E&P’s, but any lifeline that would allow them to keep production up should have helped the service names at least a little more. HAL is the weaker of the two and I guess that results from being the more heavily weighted of the two to North America.
Probably the most shocking group for me this week was the refiners. MPC, VLO and PSX just got demolished. The refiners make up about 18% of the XOP. The low input prices of cheap oil are great, but the demand destruction is huge at this point and just dwarfing the low oil price benefit. Nobody is traveling and I don’t see that changing much. It will be curious to get the Wednesday EIA gasoline and distillate numbers for the upcoming months to see the monster builds. It’s going to take long time to work off those excesses.
One surprising group (and the only reason XOP hasn’t broken 8) is the natural gas E&P’s. Remember, the NatGas names make up about 19% of the XOP. COG EQT, RRC, AR and SWN were actually green for the week. Quite an accomplishment. I’m not sure if this holds, but at least they stopped going down. Honestly though, I don’t see much more upside in this group and wouldn’t chase them here.
As for the individual E&P names, I think the most surprising one is EOG. It’s easily the best in class, but it got destroyed just like everyone else. If I had to pick one name to make a big comeback in the coming months, I’d probably go with EOG. I’d also consider COP. Who would have ever thought a month ago that we could be looking at COP under 30. There’s not much else I’d buy out there right now. I still like my PE holding and actually still like the MTDR play, although it’s going to take a long time to get back to my entry prices. I wouldn’t give up on the Permian names just yet, they should be the first group that comes back. Watch the PXD, CXO, FANG threesome, it could be a good play soon. Everything else though I’d avoid, especially any Bakken names. I also thought we might hear some M&A chatter by this point, but there doesn’t seem to be any interest at all out there. I don’t think any of these buyers are feeling any pressure to make a move, which doesn’t bode well for the recovery of the sector.
Trading Plan for Monday – I know I’ve been against this for awhile, but if we get a bounce to the 13 area on a full news week of FED rate cuts, stimulus packages and shale bailouts, I wouldn’t hesitate to start taking intraday short scalps on XOP and XLE. I wouldn’t go overnight short, because any positive OPEC/Russia headline could really spike these. Always make sure you can protect and get out if you play around short right now. The small scalp loss is ok, but an overnight gap would be a killer.
Honestly though, I really don’t expect a bounce that high and the short opportunity probably won’t develop. I have no desire to buy XOP in this 9-11 range. Playing in the middle of a range at such a low share price just doesn’t work for me. I think we get one more dip down under 8 at some point and I’ll be buying it for a swing trade and hope we get an OPEC surprise.
So, this week I’m watching 8.06 as the extreme low. For Monday, I’m watching 8.60 on the downside for a bounce. I’m watching the 10-10.50 range to see what kind of supply is there. I don’t think we are ready to get back into that Sunday-Monday opening gap yet, there’s probably a large amount of supply sitting around 10.50. If it does get in that gap, there’s nothing until 12.50. We will know immediately on the Monday open if getting in that Mon/Sun gap is a possibility. I could see them gapping this up big Monday and then dumping on it all day, especially if there is anymore positive weekend news.
Actually, I think the XLE is going to be the better trading vehicle this week. It’s set up much better structurally with clear road signs. There’s a supply level in the 33-33.50 area which should cap price Monday. If it holds after a few tests, some short scalps could be possible. If it can take out 33.50, then watch the 35.50-36 area to see if it can break to the upside. On the downside, watch the 30.25 level for the first support. If that doesn’t hold, then it’s probably back to 29. I will be watching that 30.25 level for an intraday long trade on Monday.
That’s really all I have planned for daytrading in energy this week. Most of my daytrading is now in the IWM. If anyone is interested in that one, watch 120, that should be the important level for Monday. If it gaps up/over and fades back toward 120 and holds that price, it could be a long intraday swing at 120. If 120 fails, then it’s probably a short back down to 116. On the downside, if it opens and tests 116 first, then I’ll be taking a long intraday swing there. If 116 doesn’t hold, then I’ll likely spend the rest of the day with short scalps working down toward the 111 level. It’s hugely volatile, so size enough to protect yourself and use a little wider stops than normal.
I’m headed out for the weekend ritual. They say sunlight helps kill the virus. I’m going to do some extra research and see if wine also kills it. Will start with two bottles and report back. Enjoy the rest of the weekend and get some sleep, it could be another long week.