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Next Week’s Energy Trade Plan and Few More Bearish Thoughts on the Energy Sector

Posting a quick look today at last week’s energy trade plan and what went wrong, or more specifically what never really happened at all. The plan never got an entry as XLE opened the week at 58.04 and closed the week at 58.23. The overall move for the week suggested accumulation, but I’m still not ready to let go of this short trade plan. There’s a level developing at 58.50 which should give a very clear signal this week, just have to wait for the market to tell me which way it wants to go.


I posted a fairly bearish longer term view last week, and I’ve got a couple more things to add to that bearish list this week. One thing about oil companies is that while they may know their business well (much like many fundamentals gurus) they are terrible traders. They are now deciding to make huge buybacks after the XLE has already run +150%, with many individual stocks running much, much more. They really could have timed buybacks better, but I guess they don’t mind paying top dollar now. Are they buying the top? Probably not the exact top, but they may end up making these buybacks at prices they will regret in 18-24 months and that’s not going to make shareholders happy, especially when they could have extinguished debt instead.


This week I’ve started seeing a new issue that I think is probably way worse than doing buybacks at peak prices and/or increasing dividends near the top of the oil price cycle and into a higher rate environment. That issue is the exclusion of new hedges. Many of these companies have decided not to buy insurance against an oil price crash. They bought a huge amount of hedges at extremely low prices and many are reporting excessive losses off those hedges in recent earnings reports. But now with oil pushing $85, they aren’t going to hedge? I’m really not sure they understand how hedging works LOL. It’s just another gimmick to save money in the short term, while totally ignoring the long term health of the company and industry. Many of these stocks now have ZERO safety net. If oil prices drop significantly, these stocks are going to absolutely crater. Walking the tightrope without a safety net isn’t something that larger institutions are going to be excited about because when the fall comes (and it will) there’s no way out. Just another reason that I think longer term players will abandon these stocks.


It seems like every decision oil companies are making right now just screams top of the cycle. While this probably isn’t the exact top, I think they are likely going to look back and find that it was really close. Just so many decisions being made with an incredibly short term view and no regard at all to the longer term health of the industry. Maybe they expect a government bailout when it all goes bad, who knows. Or maybe they realize, just as Bill Gates recently said, that oil is a dying business and they are trying to get all they can now with no regard to the future because they already know the future, and it’s not good. Besides, who needs fossil fuels in the metaverse? LOL.


Another issue that’s also starting to become clear is that US shale has absolutely no ability to plan for the future. OPEC really made a statement this past week when they refused to increase output and basically said it wasn’t their problem. They have created the growing bubble of $80 oil and they know it. They also know they have the ability to open the tap and crush price whenever they want. And US shale knows it too. We’ve seen this movie before. When US shale becomes greedy and decides to overextend themselves with increased capex and production (without hedges), OPEC has the ability to pull the rug and leave US shale with expensive projects that are partially developed, new dividends that are hugely burdensome, buybacks at peak prices and no hedge safety net. Are longer term institutional players going to take that risk? Doubtful.


There’s also the growing possibility that OPEC lures US shale into overextending itself right into the teeth of a recession, which OPEC is helping create. As OPEC keeps blowing the oil bubble, the real pain will start to be felt at the pump by American citizens. OPEC hasn’t shown any intention of helping and I don’t think that changes in the near future. They seem to have their sights set on pushing our economy to the brink of recession with high oil prices, while at the same time enticing US shale to overextend itself. At some point, as a recession nears, oil demand will start to collapse again. It’s at that time that OPEC steps in and pulls the rug on prices. They will try to protect themselves against loss of market share and demand destruction, but it will likely be too late for the American economy as the damage will have already been done.


When this lowering of prices occurs, OPEC will do it under the cover of negotiations to “rescue the world” from possible recession. I have no doubt they will negotiate with the Biden administration when the time is right and totally rob us blind in a deal to lower oil prices. OPEC will simply say that they were begged to bring prices down and they will walk away from the destruction with total immunity. When oil prices drop, you then have US shale overextended right into another oil price collapse with no protection. And the worst part of it is that our government will blame US shale and not government price lowering negotiations with OPEC. I feel pretty certain the oil industry is going to get thrown under the bus, all in favor of the renewable, green energy warriors. I want no part of energy stocks in that scenario and I’m guessing institutions won’t either.


But maybe I’m wrong on all the above. There’s always the possibility that OPEC never has to step in and be the bad guy. The other theory is that these oil companies increase capex, borrow and spend a ton of money increasing production – and then they find that all that supply crushes price just like it did last time. Is this really any better than OPEC popping the bubble themselves? Really seems like US shale has gotten itself right back in that familiar catch-22. And again I ask, do longer term institutions really want to gamble on that risk with prices at current levels?


As for oil itself, the latest government response seems to be future SPR releases. Are these really going to solve anything? I know we pumped a lot of light shale oil in there back in the later Trump days, so I don’t really know what quality is in the reserve anymore. But generally, releases from our SPR (and others coordinated) aren’t great for oil prices. Just another example of government doing everything they can to bring prices down, which isn’t encouraging for oil equities/stocks. It has to be concerning for institutions to see the government working against the oil industry (and in favor of renewable?). What’s next on the short term government thinking list? We can only guess, and that lack of stability has to be concerning for oil companies. How can they plan if they don’t even know what their own government is going to do adverse to their interests?


Again, I hate to be so bearish on energy, but the game is playing out just as it has in past cycles. I’m not saying this is the top for energy stocks. Anyone who has been following SPY and QQQ knows this market can squeeze higher than anyone thinks. But is that kind of run sustainable for the energy sector, especially considering oil prices are totally under the control of an entity who wants to destroy it? I don’t know where the top is for energy names, but I do think we are much closer to the top than many people think. This isn’t the level to push all the chips in long. It’s a level where you start trimming back and locking up those profits. It’s a level where trades should become much shorter in duration with less exposure to market risk. It’s a level where position size should be decreasing, not increasing.


So enough bearishness, what’s the plan for this week? I’m still watching the 58.50 level for direction in XLE. If it breaks above that level, it has a shot at taking out the highs up at 59.41. If the SPY keeps going parabolic and enters into some type of blowoff top formation, there’s a good chance XLE could even move to the 62-64 area on a final squeeze. That would be a spot where I’d load up on the short play. If XLE keeps rising this week, I’ll be on the sideline. I might scalp a little long here and there, but I’m going to let this next rally go. I don’t want to be involved in it with any longer term plays with size because I think the trade is just too expensive with the given risk/reward structure. I don’t mind missing a move, there are plenty more out there. One particular thing to watch this week are the PPI and CPI numbers on Tuesday and Wednesday. There’s also a flood of FED speakers next week around those numbers. Trading could be volatile. Also, the infrastructure plan now looks to be done, so that market catalyst is now gone.


Now, if the SPY tops out this week and rolls over, I’ll be watching the 57 level in XLE. That’s the spot where a decision has to be made and it’s the spot where weakness shows. Everyone will probably see that area on the chart as a sell on any breakdown. I’d be even happier if the SPY created some topping structure with XLE in that 58.50-59.50 area for a short play, but given the weakness in energy last week, I don’t think I’ll get that lucky. Realistically, I think the short trade will be put on at the 57 level after some topping structure in SPY. I’d also like to see IWM put in some topping structure and come back to the 234.53 level. It would be an added bonus if IWM failed and fell back under that 234.53 level at the same time as any SPY topping structure.


The bottom line in energy is that I’m willing to do some intraday scalping on the long side, but I have no desire to put on any longer term long plays over the next couple weeks. The only longer term plays I’ll consider this week will be on the short side. But keep in mind, I’m a very short term trader and my views on the market change frequently based on new information. Good luck this week, it should be an interesting one.






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