Weekly Energy Equities Review and Market Outlook for April 6-10
Apr 4, 2020 Trading Blog
So we are getting a “supply cut”. Everyone has finally figured out they can’t sell the oil and they can’t store the oil, so they are going to “voluntarily” cut supply and make a huge show of it? That’s like having no cash in your checking account and your credit card is maxed out, but you are now going to get responsible and “voluntarily” quit spending. There is nothing voluntary about any of these cuts. The oil industry no longer has a choice to cut, the market is going to make that decision for them. No matter what happens Monday, this dog and pony show isn’t going to make a bit of difference. Everyone is focused on the wrong side of the equation. Oil’s underlying problem isn’t supply, the real issue is demand.
OPEC – The New FED
We continue to manipulate the oil market rather than letting natural market forces prevail. Much like the FED has done with the stock market, this manipulation by OPEC/Russia/US just keeps the dead weight in the system and leads to harmful inefficiencies. It’s simply Oil QE. All countries should simply let the free market determine price. If shale dies, then it dies. If it was truly contributing in an efficient way, then it wouldn’t find itself surviving only because of market manipulation and endless supply cuts. Right now shale is a parasite living off of inflated prices caused by OPEC/Saudi supply cuts. We saw exactly what the price of oil should be without the market manipulation. A market is a self cleansing mechanism, let the the market do its job.
Let’s say we continue to manipulate the market and have supply cuts to keep propping up the price. What happens when they try to reverse those cuts? Remember what happened last year when the FED tried to retract a portion of the QE and rate cuts? Yeah, it crushed the market. What do you think happens the first time OPEC increases production or if they refuse to extend these supply cuts? It will crush price, or at best keep a cap on prices. When the market takes a manipulative course of action, it only leads to the need for more manipulative actions to satisfy everyone and keep the dead weight alive. Why do we keep going down that path? Down cycles are there for a reason and trying to get rid of them just damages the overall system.
So do we actually get this supply cut? I doubt it, I think it’s all just a show. It’s a public relations move to shift the blame to the United States and Trump. This was a fight Trump should have stayed out of, yet they baited him into getting involved. They are putting the burden and blame on the US now. Once these talks get going, they are going to ask the US to cut just as much as they each do. The US won’t, talks will break down and both Saudi and Russia will walk away saying,”The US had a chance to fix this, but they chose not to”. And then shale once again looks like the bad guy. I don’t see much way the capitalistic companies of the US (50+ of them) can all coordinate a cut. They have bills to pay and they will continue to pump to pay those bills. There’s also the legal aspects of price fixing and shareholder lawsuits that will get filed when an illegal price fixing scheme turns out to be adverse to shareholders interests. Trump should have just stayed out of this one and let SA and Russia have their fight. Oil’s issue is not a supply problem right now, therefore his involvement is all risk and no reward. There’s just not much to gain here and Trump will end up taking the blame when oil prices collapse and shale is finally crushed.
There is one possibility that makes this entire show work, and that’s if this whole negotiation wasn’t over oil. There’s always the possibility that Russia wanted something totally separate from the US and this was their way of getting it. I have no idea what that hidden negotiation may be, but if Russia received something behind the scenes, that would make their change of position more easily understood. Maybe that comes out in time, we’ll see.
Let’s say we do get the 10 million bpd cut, is it really going to matter at this point? Probably not. The focus right now is on the wrong side of the equation. Prices aren’t being controlled by supply, they are being controlled by demand (lack of it). As a simplified example, if the world is only using 100 barrels of oil, what difference does it make if you cut supply from 500 barrels to 200 barrels? You still have twice as much oil as you can use and the 100 barrel excess simply goes to storage. Maybe this cut will postpone storage from filling up for a few months, but that’s just kicking the can down the road because it will fill eventually, then what? The current problem is a demand issue caused by the coronavirus, and that’s not going to change anytime soon. Cut all you want, it’s not going to save the day.
Also, if we do get the cut next week, I really think oil has already priced in the 10 million bpd cut with this week’s huge jump in oil prices. If these negotiations fall apart or if the cut is anything less than 10 million, price has nowhere to go but down. If these talks fall apart, we likely get a bigger percentage oil drop than we did back on March 9 when the previous meeting ended without a deal. The best case has likely been priced in and there might not be much upside left in the energy sector. Another thing to notice is that the XLE finished the week at about the same level where it was trading when Trump first Tweeted the supply cut. It tried to run, but got rejected twice on Thursday and Friday around that 31.50 level. Oil ripped, but oil stocks didn’t and that’s a pretty clear signal that the sector is still in real trouble, even with a supply cut.
If shale does lock itself into a supply cut contract, then what happens when price goes go back up? You really think shale isn’t going to increase production with all that debt to pay back? Some companies out there have no desire to be limited by some agreement with SA/Russia, they are capitalists, and they have responsibilities to shareholders. What happens when price goes up yet a capitalist US company isn’t allowed to increase their capex to take advantage? That’s a clear conflict of interest and they are opening themselves up to shareholder lawsuits. There’s a reason we have antitrust and price fixing laws, and there’s a legal reason why we weren’t previously in OPEC. Slippery slope here. What’s to keep airlines from around the world from all conspiring to fix ticket prices? I really don’t think people have given the legal aspects of this price fixing agreement enough thought.
In summary, I think all this talk of supply cuts is pure show and probably not much of a help even if it does happen in some form. OPEC and Russia are going to laugh the Texas Railroad Circus right out of the room. All we have accomplished is jacking up expectations only to be disappointed again. And while all these negotiations and meetings drag on, those storage tanks keep filling and Putin’s bargaining power keeps growing. Just weeks ago Saudi and Russia put a boot on shale’s throat, and they aren’t just magically going to change their mind and be best friends now. They aren’t stupid and they were not surprised that oil collapsed after their actions, so thinking that they are negotiating because they are in pain is a mistake in our thinking. There’s something going on here, and it’s probably not going to end well for the US. We are being baited into a situation that we should have steered clear of.
Overall Market SPY
I’m starting to think people are truly in denial about what’s going on in the economy. It’s like they are all brainwashed that the FED is going to save everyone again. That may happen, but there’s also a chance that this is so large that even the FED can’t save it. There have been 10 million lost jobs in the first couple weeks, and the market just brushed that off. Have we become overly complacent? I understand trading with the FED liquidity rather than against it, but at some point you really have to take a step back and compare what we are seeing now to what’s happened in the past. We were at these market levels a year ago, with ZERO job losses. Are we better off now than we were back then? Will the economy get even worse? Much. I really think we are looking at some kind of delayed reaction here where everyone is currently paralyzed. The trading world is full of young guys who have no experience with bear markets. I think this gets worse before it gets better. I’m still looking at that 185-200 level. Maybe I’m just wrong, but I don’t think so.
You never want to hear anyone say “this time is different”, but does that apply now? We are dealing with people’s primal fear of dying. People can handle losing a house or a job or car. They are much more fearful when it comes to dying. Consumers all came back after dotcom and GFC, but you might not see that this time, at least not immediately. This scare has gone psychologically deeper. Even 9/11 was scary, but that was mostly a “New York” thing for most people. The virus is in their hometowns now, and that’s a different ballgame altogether. The media has really damaged American consumers this time. The social media aspect has also sensationalized things to the point where it’s going to take a long time for consumers to get back to pre-virus levels of activity. While the immediate economic impact is horrible, I think the longer term aspects are going to be much worse, and I don’t think the market is pricing that in yet. The market seems to be pricing a quick end and then a complete snap back in fairly short order. I just don’t see that happening. We have overestimated the death and danger, yet underestimated the economic destruction.
It wasn’t a bad week for SPY technically. We closed the previous week at 254 and closed this past week at 248, which isn’t too bad given the downward momentum over the past few weeks. This past week’s VWAP was ~253. Wednesday through Friday stayed in a 6 point range. The 243 level will be a big test next week. If SPY can hold that level, it could bounce and take another shot at that 263 upper boundary. I think it probably fails there, but you never know, there could be a little run left in this thing, especially if we get any good news over the weekend. On the other hand, if 243 fails, there’s not much liquidity down to the 220 area and the fall could be fast. My best guess is we make an attempt at a rally toward the 253-263 area early Monday/Tuesday, but fail and then grind lower the rest of the week.
The LQD held 121, but keep an eye on that level next week to see if it breaks down. Also, watch to see if TLT can hold 166. Financials will be the most important group next week and could give the first clue that the market might start another leg down and retest the lows. JPM, C, BAC, WFC, AXP, MS, GS were all weak. They need to show some strength if this market is going to break above 263.
Energy XLE
I wrote last Saturday that the XLE was starting to diverge from oil and the SPY, and that a bottom could be on the horizon. That bottom sure looked closer this week as the divergence got even larger. Again, be careful of getting stuck in a confirmation bias if you are short here. There are signs that this market may be turning so you have to start looking for them and accepting them. The XLE closed the previous week at 28.33 and finished this week at 29.83, or about 5.3% higher. This week’s VWAP was 29.33.
Thursday’s trade plan worked well with a short above 31 for about a $2 move back down. The same short trade worked again on Friday for another $2 move. I didn’t make any long trades Thursday or Friday. I think any long swing trades chasing that Thursday/Friday rally are very dangerous because there is still a good chance this all falls apart and if it does the XLE could find itself back at the lows very quickly. It’s just one of those situations where the reward on the long side is small and the risk is very large. There’s also the chance that even if we do get a deal that the SPY will take a tumble this week and drag everything down with it anyway. Trading the XLE long while the SPY falls is a losing proposition. I really want to see SPY break above 263 before I put on any longer term energy longs (I’ll still take intraday longs though).
The technical picture for XLE is beautiful with a perfect base forming over the last month. There was a nice move down from March 12 to March 19, a bounce from March 19 to March 26, and then a nice smaller base that formed from March 26 to April 3. We have taken three shots at that 31.00 level and all three have failed so far, but at least price has held near that level for another chance at breaking out. The real key for me is that even after we tested that 31 level, we never got any significant pullback greater than 50% of the March 19-26 bounce and there were always buyers in that 27.50 level. If XLE can hold that 27.50 level, it still has a good chance of breaking out. This week will be an important test of the 31-31.50 area and if it can break that barrier, there is room to the 34-36 level.
If the 31.50 level fails again, then watch 27.50. If 27.50 fails then there is a good chance that we continue to form a Wyckoff accumulation pattern that I mentioned last week. Before I knew that OPEC/Russia had decided to come back to the table this week, I really thought that we would continue forming this accumulation range for the next couple of months, and we still might. I also mentioned last week that if this is an accumulation range then the 26-27 area would start becoming a fair value price magnet. We tested that area on the open Monday morning and twice Wednesday afternoon. Keep an eye on that area in the coming weeks. If that 26-27 area does fail, it’s not the end of the world, it just means that the consolidation continues and we likely take another look at the bottom of the range around 23-24. Honestly, I’d rather see us build a larger consolidation range over the next couple of months rather than break out here on OPEC news. I think this market needs some time to base out and get the shares into the right hands. A breakout now puts those shares in the fast money hands and that’s not the best thing for creating a longer term trend. I’d rather see this market sit dead on the bottom for awhile and the longer term funds soak up shares and lock them up for years.
As for oil itself, the USO put in a 50% up move this week. I don’t think I’ve ever seen a percentage move that big in USO. The question now is have we priced in the best case scenario for oil? I don’t think there is much upside left. WTI should start running into big supply in the 30-33 range. It closed ~29 on Friday. If the supply cut talks break down, then it’s probably right back to 20 and possibly 15. As I said earlier, oil doesn’t have a supply problem, it has a demand problem. Oil prices moving up 50% because of supply events just doesn’t make sense. I’d be much more willing to think the 50% move up was real if it was based on a demand event. Bottom line, I don’t think this move up in oil holds, even if we do get a supply cut, because supply isn’t the problem, demand is.
Individual Energy Names
There are some absolutely beautiful charts out there right now. There are two sets of charts, ones that are close to breaking out and ones that are forming a base. The breakout charts include EOG, CVX, XOM, COP, PXD, CXO, HAL which are basically the larger XLE components. The basing charts include the second tier stocks like APA, BKR, CLR, HES, HP, NOV, MRO, XEC. The key this week is to watch the breakout set of stocks to see if they actually have enough buying strength to breakout. If they do, then immediately turn to the list of basing stocks and see if you can establish some low risk positions to see if they follow. Sticking only with the breakout stocks is always a safe option too, but sometimes it’s hard to establish a low risk position on things that have already broken out on high momentum. If the breakout fails, then you could be taking a big loss on those. At least with the basing stocks, you can usually find a lower risk entry. Some combination of both groups could be a good way to go.
One thing that has really been working this week is to watch BP, RDSA and TOT. I’ve been up at 3:50 am all week and those three stocks have been perfect in their signal for which way US energy stocks were going to go. There were some early divergences between BP, RDSA, TOT and XOM/CVX, but the former group was always the correct group. If BP/RDSA/TOT were green and XOM/CVX were red, it paid to buy XOM/CVX. It doesn’t always work so easily, but this past week it has been perfect.
Trading Plan for the Week – Monday is going to be a crazy day with a possible OPEC meeting. I’m writing on Saturday morning, so I’m not sure what news will come out the rest of the weekend, but for now, I’m going to assume that the meeting is on. I think we may get a big gap up on Monday morning, and if we do I’ll probably be looking to monitor that for awhile and then take a short position if I can find a safe way to control risk. If XLE does anything crazy like gapping anywhere near 33, I’m definitely in short. If we open close to Friday’s close, then I’m probably moving to the sidelines and let the meeting happen and then look for a trade. If things fall apart over the weekend or if we gap down Monday, then I think there will be an opportunity for some intraday trades on the long side Monday because the headlines will probably be heavy all day. I really don’t have my eye on any certain prices, because the magnitude of the moves on Monday could be anything.
But let’s just assume it’s a fairly calm day. On the upside I’m looking at the 31-31.50 area to see what kind of supply is there. On the downside, I’m watching 29-29.25 to see if there is still solid demand under there from Thursday/Friday. My best guess is we open right in the 30-30.25 area if the day is calm, and there’s really nothing there that I want to trade. I’m not getting involved unless we reach one of the outer extremes, either 31-31.5 or 29-29.25.
Quick Edit: Just checked all my news sites one last time before hitting send and it looks like there is a possibility that the OPEC meeting might be shifted to April 9. Not sure if this is true. If it is true, then look for XLE to likely gap down. This whole negotiation thing is a delaying tactic while those tanks fill, and then the power dynamic shifts dramatically.
This is one of those weekends where it is really hard to make a plan since there are so many moving parts. I’ll probably wait until Sunday night or early Monday before I make a concrete plan. I’ll try to post again early Monday morning.
So that’s where I stand in energy this week. I’ve really tried to stay off social media again this week and that has helped keep my mind peaceful. I’d definitely recommend a social media break if you are finding yourself stressed or distracted by the nonstop virus hype. You guys know my thoughts on that whole virus matter, but I would like to put the following out there for you guys. It isn’t personal opinion or venting, I think it’s something that many people are overlooking. Please give it a quick read.
Coronavirus Prevention
While all this quarantining is an immediate and temporary fix, there is something you can do to fight the virus. Strengthen your lungs and heart by getting in shape and dropping the excess weight. Quarantine might stop this first round, but you can bet the virus will be back this fall, deadlier than ever. You will get this virus as some point, everyone will. You have time to prepare. Most people will sit around and wait for daddy Trump and the government to save them, but don’t be one of those people, be responsible for your own health. I’m not saying exercise is going to save you, what I’m saying is that if your lungs and heart can’t handle the 35 minutes that it takes to run a 5k, then the virus is probably going to hit you very hard. Look, I know some people are just heavy, I’ve been there. I weighed about 240 about five years ago and I’m only 5’10. I couldn’t breath at night trying to sleep and I sure couldn’t breath after walking a few flights of stairs. Even the regular flu would knock me down for weeks and made me think I was going to die. I’d hate to see what coronavirus would have done to me in the shape I was in. Just get out there for 35 minutes and put in a 5k every day, that’s all it takes.