The BP Oil Leak Trade

by: Michael Kudrna

With crude oil being pressured and the BP plc (NYSE:BP) oil leak still flowing strong, the consensus is split on which direction we will trend next. On one side you have skeptics saying to get out before all the markets crash even though CNBC called a bottom last week. Every day, it seems I am becoming more bearish (especially when CNBC calls a bottom) as I feel we could be one disaster away from a larger correction or possible crash. This disaster could be another serious volcano disruption or more than likely a hurricane as the hurricane season starts next week. If not a natural disaster, we still have the possibility of a collapse, reminiscent of Greece. Some say China’s economy might be significantly weaker than the media has been proclaiming, which would easily allow the bears to wreak havoc. This wouldn’t be the first time major media lead us in the wrong direction. On the other side of the argument, you have contrarians loading up with the hopeful expectation that BP will fix the leak before the markets crash, if they actually do. Crude oil has fallen lower, which I attribute to psychology rather than lack of global demand. With that being said, if BP does fix this leak shortly, we could see a strong rally in crude. This rally could slingshot many beaten oil stocks to new highs but time is against us in this trade

I am currently gambling on this oil trade and it has not been a trade for those with a weak stomach. BP could still fail in their attempt, which is likely to send crude prices down another leg. I have tight stops in place as not only could BP fail miserably, but we could see a market selloff before the fate of the leak is determined. If a hurricane develops anytime soon, we would see the repair efforts halt and a bad situation turn worse. Since I have been playing defensively over the past few weeks and now sitting in mostly cash, I feel as safe as I can doing this high risk/high reward oil trade. Again, this is not a trade for those with a weak stomach.

When making a trade like this, it is many times safer to buy a basket of similar stocks rather than just one. You could also use an ETF but I prefer to make my own prudent selections on which to buy and I prefer to stay in the explosive small-caps. In this case, I am very bullish in Kodiak Oil (NYSE:KOG) and have been for quite some time to those who follow me. KOG not only has fundamentals working in their favor but some of the technicals on the chart are still strong even with the recent PPS drop. The A/D line is still showing strength, which leads me to the conclusion that we have many believers in this stock. Crude oil bouncing towards $80 could send KOG well over $4 once again. Since I have a very solid position in KOG, I have been searching for similar stocks that have been beaten down yet still have some strong indicators. The problem is the PPS is technically broken in most charts so you must look to your trusted indicators, behind the scenes of the PPS, to find any remaining strength.

Below, I will briefly cover a few stocks, which could significantly benefit from a bounce in crude oil prices. I am only covering basics in these stocks as this is a trade, not a long-term investment. Make sure you view this as a start to your own due diligence.

Gran Tierra Energy (NYSEMKT:GTE) is first on my list. GTE is predominantly an oil play focused on exploration and production in South America. GTE is a cash flow positive company with no debt and plenty of cash on hand. Yahoo Finance has GTE having $266 million in cash, which equates to just over $1 per share, very significant. Analysts estimate just below 700% EPS growth this year. GTE reached a 52-week high on April 15 and dropped significantly around May 4, when crude oil started to fall hard.

Per the 3-month chart, the A/D line is trending north with the RSI indicating GTE is oversold and the PPS is near the bottom Bollinger Band. However, if crude oil continues to fall, these indicators will surely break down as well. Crude oil has to at least stay flat near $70 for GTE to gain any traction north.

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Magellan Petroleum Corporation (MPET) is one more oil play I find promising, upon initial investigation. MPET engages in the exploration and production of oil and gas reserves in Australia, North America, and the United Kingdom. MPET is a cash flow positive company with plenty of cash and very little debt. Yahoo Finance shows MPET has holdings of about $52 million in cash, which is roughly $1 per share, and just under $1.5 million in debt. Currently, MPET does not have any analysts watching the stock, which means it is likely under the radar of most. Due to this, MPET offers significant upside potential if they can continue to improve. MPET hit a 52-week high in March and traded in a fairly tight range until crude oil fell around May 4.

Per the 3-month chart, MPET has a slightly decreasing A/D line, which seems to be trending sideways recently. The PPS is near the bottom Bollinger Band as well which is nearing oversold territory per this indicator. The CMF (21) is slightly negative at .25, but the RSI is in oversold territory with the MACD on track to reverse to positive territory, shortly. This could create a short-term bottom if crude stays flat near $70, which would allow BP time to fix the oil leak for this trade to work.

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In summary, I am looking at short-term long trades in KOG, MPET, and GTE. Currently, I only have a position in KOG but will be looking to start positions in MPET and GTE shortly. You could expand the trade to the other oil stocks and natural gas stocks with chart setups that seem promising, such as Ivanhoe Energy (NASDAQ:IVAN), Gastar Exploration (NYSEMKT:GST), and TransGlobe Energy (NASDAQ:TGA). Again, do your own homework to see if you agree. This trade has significant reward but plenty of risk and moving parts to watch closely. Take profits when you can in an uncertain market like we see today. Also, make sure to put in stops to prevent significant losses just in case the market does feel the need to crash. The small but loud group of market pessimists (or conspiracy theorists to some) are slowly growing in numbers that the market will crash this summer, so be careful. Good luck out there.

Disclosure: Long KOG but positions may change at any time