The Long Term Bet in Oil and Gas Is…

In my last article for IDE Unplugged, on May 23rd I called for a correction in the oil market, noting that the “oil is going up” trade has become very crowded and that after setting a record at $135 and surging to $140, the price of crude was due for a breather.
DL in Kansas took it that I was making a call that oil prices have “peaked”:

“I do not agree with you that oil prices are going to go down from here, and certainly not substantially. The fundamentals of supply and demand are still very much in play. The world uses 87 million barrels per day. And we only produce about 85 million. As long as these imbalances exist, how can you expect the price of crude to fall?”

Well, DL, you are correct. There is a supply deficit. That’s why I certainly did not suggest that oil is a “bubble”. I was simply suggesting that a tradable pull-back was imminent. And I suggested the way to play the pull-back was to buy the refiners.
The companies that refine crude oil make a spread between the price of oil (their input) and the price of gasoline (their output). The refiners have been getting killed on their margins for months, as the price of oil has risen faster than the price of gasoline. But the market moves in both directions. And I figured it was time for the refiners to catch a break.

The names I suggested were Tesoro (TSO), Valero (VLO) and Frontier Oil (FTO). We didn’t get much of a pull back in oil… but we got enough to push these stocks up 19%... 9%... and 10% in only seven days from the date of the article. If you purchased options on any of these stocks, you would have been sitting pretty.

So, where are we now? Well, we got a bit of a pull back in oil… enough to make those positions profitable very quickly. But here we are a month later and oil has refused to waver much to the downside. And after a sharp run to the upside, these refiners have now fallen below the price I recommended them last time.

I am still convinced that oil is due for a pull back. And the best way to “trade” it (this is not a “long-term” investment) is to bet on the refiners. If oil softens a bit and the market can stage a rally, the beaten down refining sector should benefit the most.
But don’t be greedy with your profits. In this market, they can disappear in a hurry. And watch your stops. The energy crisis is real… and the long-term trend is up.
And that’s what I’ll talk about the next time: The best long-term play on oil and gas. It’s definitely NOT the oil companies. For many of these companies their reserves and production are shrinking… and their stocks reflect it. The BIG MONEY will be made on the companies that help the petro-giants find and produce their products.

In the meantime, chew on this. The world’s energy companies will spend $10 trillion (Yes, trillion!) in the next 20 years on oil and gas exploration and production. That is a tidal wave of cash you want your money to be riding… and next time I write, I’ll tell you how to play it.

By Jon Herring