I have entered my short SPY trade as described previously. However, the global recession is causing a necessary pullback in oil prices that have gotten ahead of themselves, and I am suddenly realizing that I am far too exposed.
Oil prices have been running up, I believe, in a correlation with markets, for two main reasons: Asia, and Southeast Asia in particular, has not been as affected by the slowdown as investors are expecting – they have generated enough capital on their own to become more immune to international financing problems – and because Saudi Arabian oil production was decreased in June/July.
But now several factors are converging to hit oil prices at the same time.
Russia’s entry into the WTO, which has been well signaled for over a year, will continue to have further negative impact on oil prices, as the Russian oil will be available to more nations and more markets, increasing the worldwide supply.
In addition, Israel has publicly announced that it will not go to war with Iran. In fact, Israeli officials seem satisfied with the current level of international pressure on Iran. This removes the impetus for speculators to bet on further instability in the Middle East. Though there have been minor skirmishes related to an American video released, it is too early to tell if this will be a significant new outbreak of violence.
Without the speculative aspect, Brent Crude cannot sustain a level much higher than $100.
This is OPEC’s intended target, and they have wisely recognized that more oil is coming online and are not increasing production yet. This is one positive in the near term, however with more countries receiving Russian oil, and the possibility of Iranian oil being removed from the market being removed from the table, will provide enough negative force to push Brent to $100 or below.
The effect on WTI is less clear – the pipelines to the Gulf of Mexico have been okay-ed by President Obama, which will allow American oil to reach the world markets. However, the effects of this project will not be felt for the near future. I would expect WTI to trade roughly in correlation to Brent, though the supply/demand characteristics are completely different.
Supply in America is continuing to increase as a result of exploration and production companies concentrating on Shale oil, rather than gas. Though this will change as natural gas prices increase this winter, the glut in supply is likely to overwhelm demand in the near term, especially as unemployment remains disappointingly high.
What does this mean for my stocks?
As far as the companies themselves, I don’t expect C&J energy services or Halliburton to experience severe negative impact to earnings – exploration and production companies tend to plan on a much longer term than daily market movements. In addition, rising natural gas prices should juice earnings as exploration and production companies will likely increase their production this winter.
However, the stock prices themselves will likely be hit by the negative perceptions. Without another conference call for either company for at least a month, there will be no fundamental data to counter the negative perceptions.
The best move may be to purchase puts to hedge my investment, but I am reluctant to do so until I am sure that this will decrease my risk rather than increase it.
For the time being, I am going to sit tight, let my SPY short play out, and keep my ear to the ground for rumblings from international markets. As long as $100 forms a floor for Brent oil prices, my stocks should remain strong investments. If oil falls below $100, I will have to reevaluate my strategy.
Disclosure: I own CJES and HAL. I am short SPY.