Why This Is Not The Time To Chase Oil Stocks

We’ve entered the twilight zone in oil, where rumors and financial moves in outer markets are affecting oil and the stocks we’ve accumulated, making trading these markets not only difficult, but dangerous. We’ve got to stay disciplined and focused in this tough market and stay away from some tempting, but ultimately destructive ‘opportunities’.

Oil has put together a strong four day rally, pushing Brent prices above $50 a barrel again. But we must realize where this strong response from oil has come from before we foolishly attempt to leverage that move into good opportunities in oil stocks.

First, another meeting from OPEC and non-OPEC members has been tentatively scheduled for September, to discuss another production cut. Both the Russian oil minister and Saudi sources have floated some positive outcomes might come from these discussions. Khalid Al-Falih has said the Saudis would “take any action to help the market rebalance”, and yet the Saudis have also pushed their production in August to the highest level ever – 10.9m barrels a day. This is the kind of aggressive move ahead of meetings that signals that an agreement is very unlikely, and the Saudis (as well as the Iranians) are continuing their fight for market share, instead of ready to compromise on production limits.

Don’t get me wrong – a reconstitution of OPEC as the global supply gatekeeper is very much in the cards eventually – and is the Saudi endplay to their so-far two year assault on U.S. and other non-OPEC producers. But when that cooperation and production agreement comes, it will be when the U.S. and other producers are driven completely into the dust without hope of arising again from the ashes. The bottom line is: we’re not nearly at that point yet.

Look at Chesapeake Energy (CHK), a company I put early on my list of the ‘walking dead’. It was by far the most likely large-cap name in U.S. production that I noted was likely to go bankrupt, with its debt to equity ratio of over 4000(!). I still need to see that bankruptcy in companies like Chesapeake to believe that the destruction of U.S. production is nearing its apex and oil is truly on the road to complete rebalancing. And yet today, the company announced a new $1b funding operation with Goldman Sachs and Citigroup. That, along with the recent oil rally has sent shares upwards more than 25% in the last month. The hope, of course, is that new funding will give Chesapeake a chance to live to see $80 oil again. This is the exact outcome of competitive production that the Saudis have been strategically trying to prevent, and will prevent by not signing any production limitation - yet.

Second, the dollar index has finally shown some longer-term weakness, indicating perhaps that the highs in the dollar have been seen, and with them, the lows in oil. This has again sent the hedge funds and other speculative accounts into trimming shorts and increasing longs in the oil market, sending prices higher.

All of this is not fundamentally based – for now, stockpiles remain hugely oversupplied, and even bankrupted oil companies continue to pump oil to satisfy bondholders. A huge amount of investor and private equity money continues to hopefully chase “5-bagger” opportunities in oil like Chesapeake.

All of this to remind my readers that I do not think that this is the time to chase oil stocks. I have instead been using this rally to take profits on oil winners that we have accumulated earlier in the year. For example, I have sold more than half of my holdings in EOG Resources (EOG) after their mega positive report that send shares above $91 (from my basis price around $72). I have equally shaved my holdings of Cimarex (XEC) and Hess (HES). All of these have been huge winners that we accumulated in the spring.

Until the destruction in U.S. production is complete – a process that has admittedly gone on longer than I thought it would – there will be better opportunities to buy quality oil stocks at value prices. For right now, I won’t be tempted by financial rallies or OPEC rumors to get in at these prices. I’d rather be getting out.