Energy Week: Short Crude

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About: The United States Oil ETF, LP (USO), UNG, OIL, UGAZ, UWT, DGAZ, UCO, DWT, SCO, BNO, BOIL, DBO, DTO, USL, KOLD, UNL, DNO, OLO, DBE, SZO, DCNG, OLEM, RJN, WTIU, OILK, OILX, WTID, ONG, JJE-OLD, USOI, UBN, USOU, GAZB, USOD, UBRT, DBRT, OILD, OILU, USAI
by: SA Marketplace
Summary

In light of the geopolitical drama, oil prices are headed for a possible roller coaster ride.

Robert Boslego, author of Boslego Risk Services on Marketplace, recommends energy investors hedge their portfolios by shorting oil.

In terms of oil demand, tariffs are a watch and see for now.

Energy has been a big winner in the stock market so far in 2018. It seems the dog days of 2014, when oil prices plummeted to rock-bottom levels, are firmly in the rear view. Nonetheless, with oil prices up 40% from last year and despite being the second-best performing sector globally over the last 6 to 12 months, energy names are relatively cheap. Is now the time to back up the truck and load up on energy stocks?

We surveyed our top Marketplace authors with energy-focused services to see what they had to say. We've invited several authors to join the Roundtable. This is our last interview installment - up next is a Lightning Round to close out the series. Oil industry expert Robert Boslego rounds out Energy Week. He's a long-time Seeking Alpha author, and he runs Boslego Risk Services on Marketplace, where he manages a long/short model portfolio with trades in near-real time and provides timely insights on key oil data and events. Robert joined us via an email interview to talk about his current views on oil, natural gas, and the play he believes is key for energy investors right now.

Seeking Alpha: There's a lot of drama in oil right now, for example, between Trump and OPEC and the Saudis, and with the presence of Iran and potential sanctions crackdown looming. What does that mean for oil prices in the near and long term? How can investors play the chaos?

Robert Boslego: The Saudi position on oil production and prices has changed dramatically in just a few months. The most obvious and direct reason has been pressure from President Trump to cool oil prices, coupled with the U.S.'s withdrawal from the Iran nuclear deal and threat of sanctions.

The U.S. is attempting to apply the greatest pressure possible on KSA's chief rival, Iran, while providing security to the Saudis. The kingdom is in no position to deny Trump's request to sell more oil to restore what had become a larger-than-planned reduction in supply from the OPEC+ deal and replace any future loss from Iran due to the sanctions. The issue has become whether KSA and a few others can replace losses from multiple sources.

The alliance between KSA and the U.S. is far more valuable to the Kingdom than its OPEC relationship with Iran. Looking forward, it is difficult to see how OPEC will reach unanimous agreements, as required by OPEC by-laws, if U.S. sanctions against Iran take hold in November as expected.

President Trump has a longstanding abhorrence of "the OPEC monopoly." KSA may feel the need to distance itself from the group to retain a favorable relationship with the U.S. Pending NOPEC legislation is designed to apply the 1890 Sherman Anti-trust Act to members of cartels that attempt to "stabilize prices," which is per se illegal. NOPEC would allow the White House to apply the law to foreign governments, and companies, who could face penalties for doing business within the U.S. banking system. OPEC is reportedly seeking a legal strategy to defend against the bill if it goes into law. Passage of the NOPEC law, signed by Trump, could up-end the group's coordination on production deals.

Trump has also wanted to tap the Strategic Petroleum Reserve to help reduce the national budget deficit. And a 270 million barrel release has been authorized by Congress over a 10-year period to fund various budget bills. If the Iran sanctions continue into 2019, and Iranian or Venezuelan production falls, I would expect Trump would tap the SPR. He could add 1 million barrels per day for 9 months, accelerating the authorized drawdown.

The SPR has 660 million barrels and a drawdown capacity of up to 4 million barrels per day. The drawdown could also be coordinated with the International Energy Agency. In total, there are 1.8 billion barrels in strategic reserves worldwide.

Finally, U.S. Treasury Secretary Steve Mnuchin said some oil buyers could get waivers to continue buying Iranian supplies despite American sanctions on Iran. That is a tool he can fine-tune as events develop, depending on whether Iran must cut its production and by how much, if sanctions are applied beginning in November.

Iranian production was not affected in June following Trump's announcement May 8th, and its production may actually surge just prior to November, when sanctions may go into effect, because Iran would have an incentive to sell from storage.

A deal between the U.S. and Iran to avert sanctions is always possible, no matter how unlikely it appears now. The unlikely summit between Trump and Kim Jong-un proves that point.

The bottom line is that oil prices may be on a roller coaster ride for the next six months at least as all of this pans out. In my view, the most prudent approach for investors is to hedge their energy portfolios with short crude positions.

The size of the hedge would depend on how these events unfold. A full hedge would take away all of the oil price risk while a small hedge would retain most of the oil price risk within an energy sector equity portfolio. Being totally unhedged to oil price risk is not prudent.

SA: Oil is trading around where it was in 2010 (going up) and the end of 2014 (going down - it didn't stay there long!). What has changed for the industry through the course of that cycle?

RB: The most dramatic change has been the rise in U.S. crude production. In 2010, U.S. crude production averaged 5.475 million barrels per day, and in 2014, it averaged 8.750 mmbd. In the latest weekly data, production was reported at 11.0 mmbd.

The U.S. has also become a large exporter of both petroleum products and crude oil. In the latest four weeks, gross petroleum products exports averaged 5.3 mmbd, and crude exports averaged 2.2 mmbd, for total exports of 7.5 mmbd. That is comparable to Saudi Arabia's total exports, though it should be noted that the U.S. is still a net importer of oil.

Another major change that is often overlooked is that the U.S. produces liquids (e.g., Natural Gas Liquids) that are technically defined as "other" petroleum supply. Over the past four weeks, that has averaged about 6.5 mmbd. And so, the U.S. has become the largest petroleum producer in the world at around 17.5 mmbd, dwarfing Russia and Saudi Arabia.

In 2018, U.S. crude and liquids production is projected to end 2.0 mmbd higher, which is a larger gain than global oil consumption. The current president has also established a cooperative relationship with Saudi Arabia.

SA: Natural gas is still bouncing around in the same general range it has been in for recent years. Is there any reason to think things are going to change, and if not, what should investors and traders keep in mind?

RB: U.S. natural gas production, as measured by gross withdrawals and as marketed production, set new record highs in 2017. And these trends look likely to continue in the near future. As a result, I think natural gas prices will have difficulty breaking out of their trading range.

SA: What do tariffs mean for U.S. oil & gas imports? How is this impacting your investing strategy, if at all?

RB: Tariffs will affect global economic growth if they continue over an extended period of time, thus undercutting demand and oil prices. I do not expect President Trump to give in without gaining substantial concessions from China. The Chinese are known for exceptionally long-term planning horizons. They may hold firm waiting for a new U.S. president who is not as demanding. We need to see how this develops to factor it into oil demand revisions.

SA: What's a favorite investment idea in the energy sector for you right now, and what is the story?

RB: My best idea is to add an oil hedge (short crude) to energy sector portfolios. As discussed previously, there may be periods of significant downside oil price risk later this year and in 2019.

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You can read more of Robert's public work on the energy sector here. And for a near-real-time long/short model portfolio and expert analysis on oil, check out Boslego Risk Services on Marketplace.

Follow the SA Marketplace account above or below to get our roundtable in your inbox and stay on top of all the latest news in the Marketplace. We have one more Energy Week interview and the Lightning Round coming up, so if you're interested in hearing other views on these topics, we encourage you to follow.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.