The Time Is Right For Oil Stocks

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Manny Backus

It was shocking for many people to see gasoline prices plunge below $2.00 per gallon. Gasoline, a prime derivative of oil, had been riding a one-way ticket higher in price on the back of ever climbing oil prices.

Fears that the earth would soon run out of oil were widespread under the "peak oil" theory, causing tremendous fear that prices would never decline. Add in the never-ending Middle East tensions and a very bleak picture emerged that oil would never decline in price.

Well, things changed and they changed fast!

To the dismay and surprise of "peak oil" theorists, oil prices plunged during the financial crisis of 2008. It then rocketed higher and started trading in a tight range until the summer of 2014.

The real bear market in oil prices started in the summer of 2014. The advent and success of fracking in the United States created vast oversupply of oil resulting in a price collapse.

Unbelievable to many, the world was awash with black gold, sending prices plunging into the $20.00 per barrel area.

The plunging price party cannot last forever.

We strongly believe that the bottom is in for oil prices and now is the time to get long oil stocks.

Here's why:

Commodities move in cycles. Prices never move in one direction for long. After a nearly two-year downward price cycle, it is time for things to change.

Looking at the above weekly price chart, it is easy to see oil prices bouncing hard from the upper $20.00 per barrel zone, encountering some resistance just below the 50-day simple moving average then setting up for another assault on the moving average resistance level. This is a classic bullish technical pattern!

The fundamental case for the bottom being in for oil is even more compelling.

The Fiscal Times reports that Phil Flynn, senior energy analyst at The PRICE Futures Group, lays out a bullish case - and it doesn't just rest on crisis in the Middle East.

His argument that prices will rise after two down years starts with reasons that the global oil glut might be curtailed. For one thing, producers are pulling back in response to lower prices. "The Wall Street Journal is reporting that Tudor, Pickering & Holt, an energy-focused investment bank, has tallied 150 projects that have been delayed, resulting in an estimated 13 million barrels a day of oil production deferred indefinitely," Flynn wrote to clients on Thursday, noting that the crude that isn't flowing represents 15 percent of total global output.

Capital spending cuts as well as the normal rate of production decline is hitting the market," the analyst says.

And the added supply expected from Iran might not materialize, he adds. The U.S. is now considering imposing more sanctions on Iran, which could spell trouble for the return of Iran's oil to the market - though tensions with Saudi Arabia could also mean that the two countries won't work in concert to limit production.

Flynn argues that, when Iran does eventually re-enter the market, there will be questions as to how much oil it can produce consistently given a lack of investment in its oil fields. On top of that, he doesn't believe that Saudi Arabia is going to produce much more oil next year than it has this year. "They say they'll add more, but how much more can they? How much more could they add?" Flynn says.

Also, production from other OPEC countries might fall. Producers in Venezuela, Mexico, Algeria and Nigeria are postponing projects that are necessary to reverse the natural depletion of oil fields and even though production is improving in Libya, Flynn questions how sustainable it is due to the volatile political situation there.

Economist Sara Zervos echoed this sentiment in her recent Forbes magazine article.

She pointed out:

Nigeria, Iraq, and Turkey have suffered violence and attacks on pipelines, which has caused disruptions in supplies from these countries and from Kurdistan. While these issues are significant, they are not permanent. Nigeria's situation is likely to last until April, and Turkey has indicated it can take months to repair the pipeline. Any oil price jumps stemming from these events are thus rather temporary and confined to near-term oil contracts.

Russia and Saudi (along with Venezuela and Qatar) announced in mid-February a "deal" that they would freeze oil output at January levels. While markets may be excited at the first non-OPEC/OPEC country agreement in over a decade, in reality, the output levels in January were already at near record highs and the agreement was for a freeze, not a cut. Saudi representatives have indicated that they are still not interested in reducing production, though Russian officials seem to be striving for more aggressive agreements down the road. All in, while it shows that the two largest oil producers are beginning to squirm, it does not promise a permanent decrease in supply.

Add in the fact that global economic growth has been slowing while counter-intuitively, gasoline demand is skyrocketing in the United States and it paints a very bullish picture for oil prices.

How To Profit From Climbing Oil Prices

The most direct way a stock trader can benefit from climbing oil prices is to purchase an ETF or ETN tied directly to the commodity.

Our favorite oil ETF right now is the iPath S&P GSCI Crude Oil Total Return Index ETN (NYSEARCA:OIL).

This ETN, with the easy to remember ticker OIL, is trading in the very affordable $5.00 per share zone making it accessible for investors of all sizes.

The way it works is that the ETN is designed to provide exposure to the S&P GSCI Crude Oil Total Return Index (the "Index").

It is critical to remember that ETNs are riskier than ordinary unsecured debt securities and have no principal protection.

The ETNs are unsecured debt obligations of the issuer, Barclays Bank PLC, and are not, either directly or indirectly, an obligation of or guaranteed by any third party. Any payment to be made on the ETNs, including any payment at maturity or upon redemption, depends on the ability of Barclays Bank PLC to satisfy its obligations as they come due. An investment in the ETNs involves significant risks, including possible loss of principal, and may not be suitable for all investors.

The Index is a sub-index of the S&P GSCI Commodity Index and reflects the returns that are potentially available through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract. Owning the ETNs is not the same as owning interests in the commodities futures contract comprising the Index or a security directly linked to the performance of the Index.

Other stock market investors may prefer to go direct by purchasing oil company stocks. My favorite way to diversify and yet gain exposure to oil companies is via the Vanguard Energy ETF (NYSEARCA:VDE).

This ETF consists of a $3.1 billion asset base providing stock investors a basket of 163 energy stocks by following the MSCI US Investable Market Energy 25/50 Index.

We particularly like VDE since it charges a low relative fee of 14 bps per year from investors and is geared toward the large cap space.

No need to worry about volume as it has been averaging over 185,000 shares a day. Monster oil names like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) make up the majority of single name assets.