Weekend Edition: Contagion Risks Moving Oil Prices

When it comes to oil prices, the fundamentals are out, it’s official. Risk contagion is what’s moving oil prices higher. Will the MENA virus hit Saudi Arabia or not? That is the question.

According to IEA’s executive director, Nobuo Tanaka, Saudi Arabia is able to replace Libya’s production completely. We are talking about 1.6 million barrels of oil per day if Libya’s production comes to a complete standstill. The IEA’s is also able to release 2 million barrels of oil per day from its stockpiles for the next 2 years. (That’s a lot of supplies)

Saudi Arabia’s 5 million barrels of oil per day in spare capacity is being ignored along with the strategic reserves all over the world. Oil is getting bought as a bet on turmoil inevitably hitting Saudi Arabia where “Day of Rage” protests are planned for March 11th and March 20th according to a facebook page. (The fact that the Saudis are divided on a date will potentially cause the protests to fail.)

If the protests do happen on a large scale, particulary in the oil producing eastern territories where the Shiite minority lives you can expect another spike in oil prices.  Until the fog of uncertainty dissipates, a lot of speculative money will be pouring into oil. The profit to be made is by buying oil (futures, ETFs) not oil stocks as a spike in oil prices will knock the stock market down. The Saudi Arabian index is down at least 20% for the year (a 6 months low), the chart is not pretty!

In a normal world, markets ignore turmoil when it happens in poor countries with little or no natural resources (sarcasm intended). Unfortunately, you’re going to have to be ready for the worst if this turmoil indeed spreads to another oil producer. (Time to work on a TSX shopping list for dividend payers in case we get a 20% rebate on prices)

Is stability and $80 oil too much to ask?

Economic roundup:

Alberta ranked as world’s top mining jurisdiction

IMF: Record Food Prices May Persist as Economic Growth Boosts Demand

S&P warns of downgrades on Portugal and Greece

China to Unveil Its Strategy to Rebalance Robust Economy

Dollar’s Dominance to End: Hedge Fund Titan

Weekly blog roundup:

InvesItWisely talks about Bitcoin: The Digital Currency of the Future

Intelligent speculator lists the Top 100 Dividend Stocks – March 2011

Money Reasons explains why Paying Off Your Mortgage is Like Working at a Second Job

The Passive Income Earner covers Dividend Yield: TransCanada Corp. (TSE:TRP)

Money Smarts Blog explains How To Unlock An Ontario Locked-In Retirement Account – LIRA, LRIF – 2011 Rules

Balance Junkie on how the End of QE2 Marks D-Day for the Markets

101 Centavos shares his Trade of the Week: Playfair Mining

Buck Inspire asks Is Saving Not Sexy?

Sustainable Personal Finance provides his February 2011 Blog Update

Retire By 40 talks about his Dad’s Retirement

Enjoy Your Weekend!

33 comments to Weekend Edition: Contagion Risks Moving Oil Prices

  • I think oil is set to go higher. We’ll see this atleast till we have some stability in the ME. Even if SA is able to replace Libya’s output, it wouldn’t be doing it for the same price!

  • Wonder how the “day of rage” will go. Thanks for the mention, Mich!

  • Thanks for including me! :) Great analysis as usual. Good point on perhaps getting into oil and not oil stocks. I almost made a move and as oil prices went higher, an oil stock I was watching got slammed 6% in a day. Hard to make moves with all this global turmoil. How do you do it?

  • Thanks for the link, Mich.
    I think if there is more instability, there is a chance that production will suffer as the skilled foreigners who keep production humming leave the region en masse.

  • gibor

    “Time to work on a TSX shopping list for dividend payers ” – this is why I hold stocks like CPG, DAY, PBN who is also paying pretty good dividends :)

  • Stability and $80 would be just fine with me! I wish we (well actually the government) had done more long ago.

    Shutting down offshore drilling in the Gulf of Mexico was a bad idea in my book.

  • Mich

    @MoneyCone, I agree with you, oil will be going higher.

    @IIW, I hope they fail miserably :)

    @Buck, All this turmoil is making me question my positions right now. Haven’t decided what to let go yet.

    @101, this explains why production dropped so fast in Libya. Plenty of foreigners simply packed up and left!

    @MR, the GOM drilling licenses will be back to normal, it’s a matter of time as the government can’t afford to lose this potential production.
    @gibor, If these stocks fall on special I’ll be a buyer!

  • Wow:

    “Saudi Arabia’s 5 million barrels of oil per day in spare capacity is being ignored”

    That’s quite a bit!

    @gibor and Mich – I would like to buy some CPG, DAY or PBN if the price calms down as well.

  • Mich

    @MyOwnAdvisor, prices might calm down more than we expect in the coming weeks!

  • Thanks for the link!

    The oil concern is definitely felt in the market.

  • gibor

    Junior Gold mining is in uptrend now …I’m thinking to buy ZJG.

  • Is stability and $80 oil to much to ask?

    Yes. It is too much to ask. Oil has no ceiling because US dollar has no bottom. Sorry about that. The monetization of US debt has caused and will cause instability around the world. I’m sorry about that too. It has already greatly hurt my personal situation.

    “I wish it need not have happened in my time,” said Frodo.
    “So do I,” said Gandalf, “and so do all who live to see such times. But that is not for them to decide. All we have to decide is what to do with the time that is given us.”

  • gibor

    US$ in strong downtrend as US cannot raise interest rate like Europe/Asia starting to do. Inflation will increase. A downtrending U.S. dollar is good for all commodities (gold , silver, oil, argriculture etc).

  • Mich

    @gibor, I don’t understand why PM stocks are following Gold/Silver prices but it’s not the case with oil stocks…

    @PWD, sadly I have to agree with you as I don’t see a way out for the US falling dollar. There is no political well to do anything about it, it’s as if it is engineered by Ben and co on purpose!

  • gibor

    @Mich I din’t say they’re following.
    The US dollar is under assault by rising energy prices which also are inflationary. This is why the U.S. dollar began a downtrend as riots in the Middle East spread.
    A downtrending U.S. dollar is good for gold and silver.
    Higher inflation, better for agriculture and other commodities….circle :)

    BTW, there is info that next week big protests expected in 3 different cities in Saudia. Saudia army is ready to defend…. Hell knows what gonna happened :(

  • Jeff

    Mich,
    You stated that the money to be made is in futures and ETFs, not stocks. I do believe that you can make money in “penny stocks”/small cap oil stocks with this recent surge in oil prices. Wouldn’t you agree?

  • Mich

    @gibor, Well at this point you either sell and sit on the fence or you close your monitor for the next few weeks. If you sell now, you are playing the market timing game which might or might not be the right decision to do.

    @Jeff, oil stocks are not following oil prices. Stocks in general will be pricing in a coming recession if oil prices increase substantially higher. Let’s see what surprises the Saudis have for us…

  • Jeff

    Mich,
    Ive found that several small cap oil production stocks have increased steadily over this past week. Maybe the high prices of crude oil aren’t directly pushing these stocks up, but I think that many speculators and day traders are buying up these stocks b/c of the prices of crude oil.

  • gibor

    @Mich, “Well at this point you either sell and sit on the fence or you close your monitor for the next few weeks. ” – probably 2nd option is better, because when my monitor is open I’m tempted to sell…and from previous experience in many cases it’s a wrong move.
    Today happening what I was afraid of, despite rise in oil and gold, almost all (with very few exceptions) oil,energy, gold stocks fell down. The funny part that Dow fell much less than TSX.
    and seriously , I’m in big doubt what to do, from last week I ordered limit sell on CLO (in order to walk out at least with some profit) and today CLO came dangerously close to this limit.

  • James_Bond_007

    Ya can’t go wrong with etfs in these markets. You can price in your risk range depending on what weighting you wish to have in whatever sector (ie energy) with the varying etf’s out there. If you want to play on the cusp of these market fears then you could enter an all oil etf like hou (mentioned this a few weeks ago) which could have netted you a 45% return in three weeks, a much higher return than you would have seen on most any oil stock. I think that copper could prove a good buying opportunity on a pullback right now. I have placed a limit order on a key etf that has a very small float and if copper keeps in this uptrend it has great potential, i feel, for a share split. If you believe in the future of copper then eqn should also prove a good growth stock if the deal goes through as planned.
    Anyways, back to oil. Picked up some ale last week at .28. Can’t say I trust the company any further than I could throw them but they have handed operatorship over to PRE (which I would trust as far as I could throw them), on a 50/50 venture block. This block could be a game changer for this company. I also believe that the 70 million financing that they just put through has a few “behind the scenes” strings attached which seemed to show through with today’s press release.

  • Mich

    @Jeff, This is also the seasonal drop as spring breakup is soon upon us. Add the uncertainty of oil prices and you have yourself money leaving this sector as it is evident of this week’s action.

    @gibor, I guess our turn for a correction is now. I do not stress much even-though I see paper losses appear and paper profits melt as I believe it will all recover later on. Maybe it’s a big mistake to focus on fundamentals so much, on the other hand I don’t have much of a margin to worry about it so I can wait it out if I choose to.

    @JB, Good luck with ALE, a brave move and I like your thesis behind this decision. PRE makes the difference in this case, now all you need is a hit.

    Haven’t been watching copper but you might be right. The only non-energy stock that got my attention was CLQ as they got a nice haircut recently. However, I am reluctant to deploy more money now until things clear up.

  • John

    Do you have any plans for an exit strategy should things turn sour or if you notice signs that instability is imminent? I noticed that you are invested heavily in juniors and that your top picks for 2011 are REL, SKW, ARN, BWD. Are you still as confident with these and the other energy companies for 2011 with a possible crisis up ahead?

  • Mich

    @John, I am still holding REL and SKW and I might pick up BWD(riskiest) and ARN again if prices collapse.

    exit strategy would be a big word, maybe lighten up but not exit completely. Whatever decision you take now is a bet on the short term ie market timing because you believe Saudi will be next or some other opec producer is next. Does anyone know what’s coming next? no, the best defense is to remain margin free. More than that and you’re speculating, you could be right and you could be wrong. Lots of variables remain unknown in the short term, but in the long term it will all settle back because no one can afford to let the world economy slip into turmoil for an extended period of time. Oil demand is not going anywhere anytime soon, as long as prices are above $75, stock prices will recover as investors “remember” that these companies are still very profitable at these prices.

    Of course, not every one can stand looking at significant paper losses, so to each his strategy when it comes to uncertainty.

  • In my opinion, the term “exit strategy” should not be in the vocabulary of a Canadian junior oil and gas investor. The important thing is the fundamentals: book value, proven reserves, p/cash flow, track record of the management team, etc. If you must have an exit strategy you’re better off buying condors or collars where risk is mitigated: see http://blog.mdwoptions.com/ Of course, that means that you are not trading junior oils anymore because there are no options available for them; in junior oils, if you want to play, you’ve got to pay.

    The real question is dealing with market irrationality. If you’ve determined that a company is a good deal when commodities are at a reasonable price (say $60-80 for oil), then the exit strategy will only lose you money. A friend of mine said that he was going to buy a junior oil with a 15% exit strategy. I said to him, don’t bother. You will just lose money. 15% is a standard daily/weekly variation for small cap oil stocks.

    I’d encourage everyone not to get cold feet and to maintain very solid excess margins. If you can’t take a 70% or more loss on a junior oil stock, it may be better to save your marriage and only bet what you can afford to lose. But I don’t think an exit strategy is the way to go.

    As Mich knows, I averaged down on Trafalgar Energy even at .39–the book value was listed at $3.40. One day in January 09 I bought 9000 shares at that price. Guess what? It’s up to $4.79 today and it is now called Midway Energy (MEL). My worst pick in the last couple years was Midnight Oil(now Pace / PCE). But the fundamentals price/book were excellent and I stuck to my guns. The market has finally given it a lift and I’m back in the green.

  • Mich

    @PWD, We are on the same bandwidth, fundamentals will be recognized sooner or later. We are buying into a business that is generating profit not betting on red/black chips at the casino.

    I went through the uncertainty of H1 2010 by buying more at the time and it paid off handsomely. When you invest in junior oil stocks, you have to remind yourself WHY you invested in and what your expectations are. Anything else is gambling on trend and emotions.

  • James_Bond_007

    Placed a call to nvs today and spoke with Jullian Din. I like the fact that he was very helpful in answering what questions I had. Investors can expect a news release next week, most likely an update on the 3 wells drilled and a updated year end.

  • Mich

    @James, Thanks for the update RE NVS. This is another good one I missed out on. Can’t hold them all eh :)

  • James_Bond_007

    As long as you hit more than you miss! Grabbed some tol.vn at 3.83 and tt.to at 1.15. Looking forward to your next post, always a good read!

  • John

    Thanks guys, really appreciate the insight on this. Im a young guy still learning the ropes on this and would like to understand a bit more on how you guys are making your investment choices, which is why I follow your blog. At first, it’s hard not to panic when you see a promising stock dip -15% or more in a short time period. Example, PMT in fall 2010, TOL and SKW recently.

    I was too young to pay attention to the recession of 2008, but it appears that another similar crisis can possibly take fold if the events in the middle east get worse so Im really curious on seeing first hand how this affects the various areas of the market.

    Very interested in seeing how your junior oil picks will perform in the next year. Just bought SKW yesterday as Ive been following that one for a while and have been waiting for a good entry point.

  • Mich

    @John, my junior oil picks all recently recapped, have production and lots of land. That will not shield them from crashing with the market but it’s good to know I don’t have to worry about them going belly up if we hit air pockets as I am patient and the year is still young.

    You have to know your risk tolerance and always make sure you don’t get caught with your pants down = Remain margin free when the market is in turmoil.

  • Mark

    With all the hot money in oil, I would be watching for the rug pull. The speculator chant is starting to get louder.

  • Mich

    @Mark, I can only nod in agreement…

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