Contrarian Play In Exxon

| About: Exxon Mobil (XOM)

Summary

Oil is at the low end of the year, and higher oil prices help Exxon's upstream projects.

Commercial hedgers unwound 190K short positions when oil traded around $54.

CRB index is at its low for the year. Oil is the largest composition of this index.

Exxon Mobil's (NYSE:XOM) stock has underperformed the S&P 500 for the last three years with the collapse of oil. Despite the poor performance, there have been times to buy the stock for an intermediate trade. This may be one of those times to go long.

Exxon Mobil performed better than its counterparts with the steep selloff in oil between 2014 and 2016. As of June 16th, the stock was trading at $82.77, which is approximately 10% lower than its 2014 high. It's a positive sign that Exxon's price has fallen 10% since the last oil top, while oil fell over 50%. Its business model of hedging against lower prices enables its stock to remain higher than its competitors'.

Oil companies like Exxon depend primarily on upstream projects, which consists of searching and drilling for crude oil. Due to the hard correction in oil, upstream revenues decreased dramatically. Exxon's decision to invest in downstream projects (refining of crude oil) saved the company from a substantial haircut in the stock.

Exxon reported a strong 2014 with over $32 billion in net revenues with upstream profits consisting close to 90% of that revenue. 2016 earnings showed a different story with total revenues of $7.84 billion. Less than 3% of the total revenue belonged to upstream projects. Just as the lower oil prices weakened Exxon's stock, it also reduced earnings by more than 75%. Higher oil prices are needed for Exxon to deliver strong earnings.

Darren Woods, Exxon's CEO, stated that Exxon plans to invest $20 billion in 11 downstream projects over the next decade in the Gulf Coast. These future investments allow the company to diversify its upstream projects. The major problem is the excess supply and the uncertain nature of the oil market. By pouring more money into downstream projects, this protects Exxon from an adverse move in crude prices. As it learned in 2016, downstream revenues can save it from an oil shock.

Understanding the positioning of the futures markets provides an insight into the direction of price. The commitment of traders report indicated that the commercial hedgers (smart money) are net short 377,005 contracts for crude oil as of June 13, 2017. Earlier this year, the same group went short 571,785 contracts. Compared against the last two decades, this was the largest net short position recorded. Oil peaked out around $54.00 at this extreme net short position. Commercials closed out 194,780 short contracts within the last three months, and oil prices fell $9.00.

Now sentiment is bearish near the lows of the year vs. when oil topped out at $54.00. The speculators (non-commercials), on the other hand, liquidated 197,608 contracts during the same time. Speculators are known as "dumb money" at position extremes, and this time was no different when oil hovered at the top. Since the dumb money fled their positions, this may be a signal to go against the dumb money from a trading perspective. Although the speculators closed out several short positions, some positive news for the bears is that the non-reportable traders added roughly 2,000 long contracts during the same time frame. The non-reportables are considered dumb money since they are retail investors that have a poor track record compared against non-commercials and commercials.

A positive set of news for those willing to buy Exxon is that the CRB Index is at the lows of the year around 173. In addition, the RSI is in the low 30s and towards the lower end of the Bollinger band on the daily chart. 23% of the CRB Index consists of oil, and heavily influences the pricing of this index.

Although there is evidence that the crude market is close to a bottom, the number one problem is the glut of inventories. The EIA indicated inventories increased over ten percent over the past year. More negative news for the bulls is that U.S. oil firms increased the number of oil rigs on hand for the 22nd week in a row. In addition, supertankers store an excess amount of oil in parts of Southeast Asia.

OPEC committed to reduce oil inventories at 1.8 million barrels per day. Nigeria and Libya, OPEC members, are excluded from this supply cut. These members previously experienced problems with rebels and a supply interruption. They resumed exporting oil, which doesn't help OPEC's cause. The global surplus of oil failed to lower oil prices this year. Initially, oil rallied back to $50; however, oil is currently hovering around the lower end of the trading range for the year.

Despite the bearish news, there is some positive news for the bulls coming from the EIA report. Irina Slav, a contributor to oilprice.com, stated, "total inventories were 511.5 million barrels, in the upper half of the seasonal average, which could be seen as a cause for optimism after several months of inventories exceeding the seasonal maximum." If inventories remain flat or even decrease, the worst is over now for oil.

With crude oil decreasing, shrewd investors stayed away from Exxon. Even if oil trends lower, Exxon benefits from its downstream portfolio. Despite the negative news regarding crude, Exxon may be a nice contrarian play for an intermediate trade for the summer. As the weather improves this summer, the demand for crude should increase prices. There are concerns about an inventory build and slowing economy. However, since markets don't go down in a straight line, one can potentially take advantage of this situation.

Disclosure: I am/we are long OIL, UCO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long oil in the futures with bullish put spreads.

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