Is The Disconnect Between Oil And Oil Stocks Dissolving?

I’ve commented for weeks upon the disconnect that continues between the price of oil and the prices of oil stocks. In the past, you could set your clock based upon the correlation between oil and oil stocks, and my successful trading career has in no small measure depended upon this correlation.

But my very correct call on oil prices, now above $70 a barrel in Brent, has not so far been rewarded with concurrent gains on our oil stocks.

Is it possible we are seeing some light at the end of the tunnel? On Wednesday, that disconnect took a few small steps towards dissolving. It has been a long time since I can recall a day when the larger stock indexes were down and yet the energy sector posted positive gains. Yet this happened on Wednesday.

But – let’s not get too hopeful yet. We have also cautioned about volatility and the difficulties it delivers. We’ve noted the continued prospect of a trade war with China, saber-rattling in North Korea and Iran and in the last days we’ve seen more geopolitical risk with a possible retaliatory missile strike in Syria and more Houthi missiles launched from Yemen flying over Saudi Arabia.

Despite the positive action recently in oil stocks, we still note that volatility is not normally a positive sign that we should blithely accept. It will require a bit more work to manage through this wild moment in the stock market, and I am looking at this mini-recovery in oil and oil stocks as an opportunity to realign our portfolios a bit.

So – where am I going?

I am going to reiterate the recommendation to use this relative rally in oil stocks to remove exposure to high-beta shale producers and add exposure to dividend-paying majors – particularly euro-majors like BP and Total.

But inside the shale players, I’m going to recommend a further shading away from the overplayed and now under-performing Permian producers. It’s become clear that the ‘mania’ for Permian acreage has over-hyped this sub-sector – with the latest $5b addition of capex from Exxon-Mobil as a possible signal that a top might have been reached. Exxon has an unfortunate track record of calling tops in natural gas with their XTO purchase in 2010 and their Russian projects, which they recently needed to completely write off. While concentration has centered on the Permian (including from me), what’s gone unnoticed is the increased efficiencies and cost per barrel savings that have extended to other, more mature plays - particularly in the Bakken, where Continental Resources (CLR) has quietly crept up from trading in the low $50’s in early March to trade above $61 today. Besides Continental, Whiting Petroleum (WLL) and Hess (HES) stand to equally benefit from this Bakken ‘renaissance’. As Permian players rebound, we’ll likely see these Bakken players lag, giving us this opportunity to do a bit of ‘shale swapping’.

Finally, in trying to stay ahead of trends instead of reactive to them, I’ve been gauging a time to reenter into the natural gas trade. I have been advising to stay away from this sub-sector for the better part of three years now, and wisely so. But I remarked in recent columns that there were signs that natural gas was putting in a long-term bottom. Indeed, if there’s been a disconnect between oil and oil stocks, there’s been an even more glaring one between oil and natural gas. It would seem likely that when that disconnect begins to moderate – as it always does, sooner or later – that natural gas stocks would show even greater value – and greater potential gains - than oil stocks do right now.

This week, I’m going to begin a long-term position in one or two choice dedicated natural gas E+P’s. I have centered on Range Resources (RRC) as one of them, and find it a pricing positive that they were recently downgraded, first in January at Morgan Stanley and then more recently in March by Bernstein. I am well aware of their debt positions which seem to frighten these analysts, but in spite of these downgrades, the stock has acted – in my view – very well indeed.

Always trust the market – and yourself - before you trust analysts.

By Dan Dicker