Weekly Energy Equities Review and Trading Plan for March 23-27
Mar 21, 2020 Trading Blog
The biggest question I see on Twitter is, “Is this the bottom?”. I think that’s probably the wrong question to ask. The real question is, “What happens after we reach the bottom?”. I think many traders are making an assumption that a bottom will necessarily lead to an uptrend that returns to prior levels. Some bottoms do, but most do not. In the case of energy, we could be very near a bottom, but instead of a “V” type recovery, we could be looking at a long sideways consolidation that lasts for months. If this is true, then you have to plan your trades accordingly. Will you be willing to tie up your money while you wait it out? Will you be willing to hold your stocks when we inevitably test the lower bounds of the range, sometimes dropping sharply below on shakeouts? Even if we know for a fact that this is a bottom, would you want to buy it if the next step was a consolidation rather than a “V” type uptrend?
So, let’s start with the first question of whether this is a bottom or not. My opinion is that we are getting close, but I don’t think the final lows are in yet, either in energy or the overall market. I think energy is closer to a bottom than the overall market, mainly because energy got a head start on the way down. For me, the XLE now more truly represents the energy sector. For a long time, the XOP was my trading vehicle of choice, but the crash in E&P’s has skewed that ETF to the point where it doesn’t even represent oil E&P’s anymore. As of Friday’s close, there were 57 components in the ETF and the top five holdings were COG (6.9%), SWN (6.1%), EQT (5.7%), RRC (4.6%) and CNX (4.1%). These five natural gas stocks make up 27.4% of the ETF. I wouldn’t touch any of those companies even with someone else’s money, much less my own. In addition, refiners still make up 14.8% of the ETF. These five natural gas stocks and seven refiners make up 42.2% of the ETF. This is NOT a true representation of the energy sector. The only time I will be trading XOP in the future is when I see refiners and natural gas stocks both moving in the same direction as the oil E&P’s.
I kind of got on a tangent there, but getting back to whether this is the bottom in energy, let’s review that question using the XLE instead. The high water mark for the XLE will be 55-60 for at least the next year. Given that as the high, we closed Friday at 25.86, so we are down a little over 50% from a definable point. The next question is where is the low water mark? There are three events that have yet to occur which will define the bottom in energy stocks. Those three events are a bottom in the SPY, a bottom in oil, and the performance of the oil majors, more specifically whether they intend to cut dividends. Keep in mind, the top two components in the XLE are XOM (24.96%) and CVX (23.86%). Almost half the XLE is made of just two stocks. It’s not an ideal way to represent the energy sector, but it’s much better than the XOP. In the XLE, midstream/pipelines make up ~11%, refiners ~11%, services ~7.5% and oil E&P’s ~20%.
Let’s take each of the three events separately. The most important event is finding a bottom in the SPY. It closed about 229 on Friday. The most important fact for me was that we got almost no bounce off those December 2018 lows. There was some demand there, but it wasn’t enough to produce any meaningful bounce. I was looking for a bounce to the 286 area, yet price couldn’t even take out 250. Maybe that bounce still happens, but each day that passes makes that possibility smaller. The lack of bounce suggests there is more downside to come, and given the virus panic and all the shutdowns, the question becomes how much more downside? The next major demand should come in the 200-210 area, which was the 2015 high range area. The lower range area of that period comes in around 185. I’m expecting price will probe that 185-200 area looking for demand. Who knows if we find it there. Given that that the XLE is largely XOM/CVX, and that those two are both Dow components, if the indices drop then both stocks will get sold off in sync, which results in the XLE falling still further. Even if the energy sector does get some support, XLE likely won’t because of the pressure exerted by the overall market. In that situation, it becomes more important to look at individual energy stocks to gauge how the sector is holding up. If we do that, then COP, EOG, PXD, OXY, CXO and HES become the E&P’s to watch. In summary, I think the overall market has further to fall, so energy will likely get pulled with it.
The next event is oil price. WTI bottomed out around 20, but got a nice dead cat bounce to the 28.50 area before fading back to close the week at 23.64. I’m guessing we probably head right back to 20 this week, probably lower. The conflict between OPEC and Russia hasn’t improved and probably won’t improve anytime soon. To make matters worse, the US is getting involved in something that they should likely just stay out of for now. That Texas Railroad Commission involvement was pure hype and likely means nothing. Any interference by the US is just going to draw the ire of Russia and force a retaliation move on their part. Russia has the power right now to crush oil prices even further if they wish. As the storage fills, Russia’s power will grow. If storage does become full, then there’s going to be a price collapse and shale is done. They can’t export it and can’t store it, so the only choice is to leave it in the ground. Putin is playing the long term game here and his big reward shows up when storage is full. I wrote my thoughts on the SPR plan last week and the storage issues just extend the game and provide Putin with a bigger reward at the end of it.
But even if we didn’t have this conflict and they had instead cut supply, would it have even mattered? Probably not. The problem right now is extreme demand destruction. You can cut supply all you want, but if nobody is using any supply then it really doesn’t matter. Everyone’s car is sitting in the driveway for at least the next three weeks and hardly anyone is flying, so demand isn’t going to move much. The real question will be if we have scared everyone so severely that even when this does pass will they revert to pre-virus travel levels? With all this demand destruction, storage is slowly filling. I think oil prices are going to recognize this in the next couple weeks and therefore I see lower oil prices. If prices continue to fall, energy stocks really have no choice but to follow. Any divergence between oil and energy stocks, with stocks rising on declining oil, would be a screaming signal that we have reached a bottom.
The last event is the health of the oil majors. As stated above, the XLE is made up mostly of XOM and CVX. I fear that a cut of the dividends on those majors is coming. We can throw BP, TOT and RDSA in there as well. If they cut the dividend, there is a class of investors who will throw in the towel on these stocks and dump them. This same rationale also extends to the larger E&P’s with dividends. The yield on these stocks is huge right now, but there’s no way that lasts. Investors might tolerate stock price declines if they are getting paid to wait, but take away that incentive to wait, and they won’t be patient any longer. If the dividends get cut, we are probably looking at 20% downside in XOM and CVX. I think the market has probably already priced in the chances of this happening, but the actual shock of it, combined with desperation selling in the market overall, will cause investors to sell these two at any price. I could see XOM going low 20’s on a washout. If you have cash, that’s going to be a once in a lifetime opportunity.
In summary, we have three major events working against stock prices in the energy sector. I think we go lower, but estimating how much lower is difficult. If I had to put a number on it, I’d say the XLE could drop to the 18-20 area in the next month. As for XOP, the natural gas stocks have been moving up whenever the oil stocks move down, so who knows where that ETF ends up. As an aside, this adverse movement is due to the fact that when the oil companies curtail oil production, this also cuts associated natural gas. This is like a supply cut for natural gas and should support price, which helps the companies who produce natural gas as a majority of their revenues. If any of the three events don’t occur or if things really start to improve, then I’ll revise my outlook, but right now I’m pretty bearish.
Trading Plan for the Week – The week in energy ended on Friday with an encouraging sign. When the SPY tanked to new closing lows during the last hour, there was huge demand in energy. Around 3:15, the XLE ripped from 24.75 to 26 in about 15 minutes and then sat near 25.90 for the final 30 minutes as demand soaked up millions of shares. This usually wouldn’t have been such a big deal (Tuesday through Thursday all had positive moves in the last 30 minutes), but this happened at the same time selling in SPY was overwhelming to the downside. Individual energy stocks also had solid demand, with many of them spiking more than the XLE gains. I don’t know if this was a well timed short cover or if there was truly a buyer who was putting on a long position. Either way, there was a great deal of urgency on that purchase. I guess Monday’s opening will disclose what it was. If price gaps down or if it stays down after the first hour of trading, then I’d guess that Friday’s buyer was a short cover looking to get out at a great price. Sometimes the market offers you liquidity and you have to take it. There’s also a chance that someone sensed that there was going to be some type of positive development in the OPEC/Russia situation, however I haven’t seen any positive news as I write on Saturday afternoon.
Looking at the technicals for XLE, the VWAP for the week was 26.20. Friday’s VWAP was 25.84. We closed at 25.86. That huge buyer on Friday still managed to fill his order under the weekly and daily VWAP, which was a success on his part. The most important price point next week will be that 26.20 weekly VWAP. If price can sustain above that on Monday, it would signal that the buyers are making an attempt at regaining control. If 26.20 fails and gets rejected, then the sellers regain control. The speed at which price moves away from 26.20 will tell how powerful that control is. The next most important price point will be the weekly low at 22.88. I think there is a good chance that gets retested this week. On the upside, there should be supply in the 29-30 area that could stop a price run. I’d be surprised if price got above that this week.
I’ll be daytrading the XLE this week instead of the XOP, so if you don’t see any daily levels for XOP, that’s why. I wrote about representation bias a couple weeks ago and that bias is really hitting XOP hard. Ideally, I’d like to see XLE gap down and retest the lows early Monday. If it overreacts to any bad weekend news by retesting the 22.88 lows, I’ll be a buyer for a morning bounce. The more likely play though will be a pullback to the 24.80-25.00 area and that’s where I’ll be looking for my first long daytrade. I don’t have any desire to short energy right now. The thing that I don’t want to see would be a gap up to the 27 area. If price gaps there, then we probably set ourselves up for an all day fade and sell off, and that’s a much more difficult situation to trade. I trade both directions, but any surprise in energy is going to produce an outsized spike up and I just don’t want to play with those landmines right now, the market is already volatile enough. I’m still daytrading the IWM, but the volatility there is just so difficult to deal with. Sometimes things even move too much for a daytrader. If anyone is trading the IWM, keep an eye on that 100-101 area, it could provide a good intraday long opportunity with a tight 50 cent stop. One quick reminder for the 3x ETF crowd, the UWT and GUSH reverse split on Monday. I don’t trade these, just too much risk.
For XOM, watch the 34-34.50 area for signals about how much supply is still over the market. I think this one probably tests the lows again this week around 31. CVX got hit much harder this week than XOM did. From top to bottom, CVX was down about 34%, while XOM was only down about half that. There’s a big gap between 60 and 72, so if this market does start to run this will be the first stock I’m going to be looking at for a long play. If SPY looks positive, I’ll be playing the breakout of the 60-61 level in CVX. I don’t have any desire to play XOM long.
In individual names, I still like the CLR trade that I posted Thursday. It made an attempt at breaking out of the consolidation range on Friday and finished at 9.50, up +3.7%. It’s still in the range and any pullback toward 8.75 could be a nice long trade. The stop on that trade is still 8.25. If the XLE can find some support on a pullback, I like EOG on any pullback toward 30, COP on a pullback to 24 and PXD on a pullback to 58. Two stocks that I think are flying under the radar are HES and XEC. These two stocks are more natural gas weighted than many recognize and have formed some defined technical patterns. I’m looking at HES in the 29-30 area and XEC in the 13.50-14 area. Again, any long plays would have to be supported by an upward SPY, stable oil prices and the XLE finding some demand.
I try to write down my thoughts every day in a notebook, mostly things I do wrong and how the market is acting each day at certain points. One of the things I’ve noticed is that I’m getting immune to the volatility and market swings. That is a dangerous thing and it can happen so slowly that it isn’t even noticed. I’ve found myself putting on the same size (number of shares) trades now as I was putting on last month. The risk in this market has changed, therefore risk tolerance must also change. Positions need to be smaller and stops need to be wider. As volatility changes, the way we trade must change. Sometimes I haven’t been making those changes because I’m not noticing them. Just something to keep in mind in your trading. Hope this maybe helps another trader out there somewhere. Controlling risk is the most important part of this game.
Anyway, that’s what I’m looking at in energy. As for the coronavirus, I’ll try to keep my thoughts on that to a minimum, as I realize you guys follow me for oil and gas thoughts, not my personal virus or political thoughts. Sorry if those thoughts have offended anyone, I’ll try to keep them to a minimum from here on out. Not sure what I’m going to do on Sunday without my ritual trip to the winery. It may be a day of cheap wine sitting on the back deck with the radio, and sometimes that isn’t so bad, at least the commute is safer. Hope you guys have a great weekend.