The Vladimir Put And Why Now May Be The Time To Buy Oil Stocks

by: Josh Young

Concern about a eurozone breakup and a run on Spanish banks is on the rise, the economy in the US and globally seems to be slowing down, and just as oil demand is decelerating, worldwide oil production is growing. As a result, oil prices are crashing like it is 2008, with WTI down 20% from $105 to $84 in the past month (and oil ETF USO is down from $40 to $31.50). And oil and gas equities, as measured by the ETF XOP, are also down about 20% in the past month.

At times like this, the natural tendency is to panic and sell, or for the more aggressive, to go short. Momentum is a powerful effect and the psychology in this scenario is overwhelmingly negatively.

However, I think Warren Buffet words in the Berkshire Hathaway (NYSE:BRK.A) 2004 Chairman's letter are timely: "Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful."

And in this case, there may be good reason to be greedy. Lost in the sea of negative news about the global economy and concern regarding excess production is a key geopolitical factor supporting the price of oil - oil exports are concentrated among a few key countries, the biggest of which is Vladimir Putin's Russia.

Russia produces just over 10.5 million barrels of oil per day, which is approximately 12% of the total world oil supply. Oil accounts for 17% of its GDP and contributes 40% of government revenue. Russia is highly economically dependent on maintaining a high price of oil.

There is not currently much worldwide spare oil capacity. Recent estimates I've seen are 2-3 million barrels per day, almost entirely in Saudi Arabia (which is also incentivized to keep oil prices high and has publicly targeted a $100 Brent oil price). And in the global physical market, supply is tightly matching demand. And OPEC may be cutting production by over 1 million barrels soon, according to Morgan Stanley.

There are several ways Russia could help support the price of oil (or cause an oil price spike). The first would simply be to export less oil - if Russia cut its production by 10%, that would be over 1 million barrels of oil per day, which in a tight market could be enough to push the price of oil up by more than 10%. Another way to accomplish a similar thing would be to withdraw support for Iran, allowing further sanctions or possibly even military action against it, potentially taking some or all of Iran's 4 million barrels per day of production off the market.

The attractiveness of these options to Russia is contingent on the price of oil, among other things. They become much more likely as the price of oil falls. Thus, there is effectively a "Putin Put" on oil, where if the price falls below an acceptable level, Russia will be more likely to take one of the actions described above. This reduces the chance of a 2008 style price collapse, and increases the chance that any further oil price drop will be temporary.

I own stocks that I expect to benefit from sustained or higher oil prices. These include Gale Force Petroleum (OTCQX:GFPMF), Gastar Exploration (NYSEMKT:GST), Sonde Resources (NYSEMKT:SOQ) and Molopo Energy (OTCPK:MLOOF). These stocks are down more than the oil and gas index (NYSEARCA:XOP), but as oil prices stabilize and recover, I expect them to outperform XOP and the underlying commodity ETF (NYSEARCA:USO).

Disclosure: I am long OTCPK:MLOOF, OTCQX:GFPMF, GST, SOQ. I am short a small amount of XOP and USO as hedges, but am substantially net long oil exposure