A New Gameplan for Energy

 | Oct 24, 2013 | 1:30 PM EDT
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Oil has been headed down, or at least our domestic benchmark has shown continuing weakness over the last five days.

Our investment philosophy has been to concentrate on the domestic E+P players since the spring and we've done fantastically well by loading up on mid-cap E+P names like EOG Resources (EOG), Noble (NBL) and Cimarex (XEC).

But what should we be doing now?

First, it's important to understand why oil has dipped. There has been, of course, a lessening of geopolitical risk with the Syria chemical weapons agreement and the overtures of sanctions ending from the government of Iran. But here in the U.S., an increasing supply of crude from the shale plays in the Bakken and Eagle Ford has also combined with a group of maintenance shutdowns of refineries on the Gulf coast, expanding the surplus of supply in Cushing, Okla. 

It has been the highest beta E+P names that have been hit in this downturn, but I don't think it will be a long one. My thesis on oil has been mostly unchanged in the last five years: it will continue to make higher lows, with the upside limited only by geopolitical tensions.

Have a look at this chart I made up last month.

It indicates to me that these downdrafts are unpredictable, but also short-lived. With the upward triangle formation I've sketched, you'll likely see prices in the low 90s before a recovery begins. 

So, how should you play this new trend? 

One thing I truly believe is that each of these mid-cap E+P's we've recommended will report fantastically for this quarter, having grown in production and realizing a base price of well over $105 a barrel. 

Noble proved that this morning and was immediately up 5% because of it. This is the trend we believe will continue.

But that bounce in earnings is a great opportunity to lighten up on the mid-cap focused E+Ps we've relied upon up to now. With oil under $100 and the Brent/WTI spread widening, there are going to be better places to capture value going into the fourth quarter and into the first quarter of 2014. 

It's now that we want to look at the underachievers who might have a bit more of a spread of assets and even try to short-term trade the refiners, who have been laboring under a bad margin profile for the third quarter, but will be able to take advantage of a much better one through the rest of the year. 

So, the plan is to wait for earnings, sell at least half of your exposure in these higher-beta E+Ps and look for opportunity in the lower-beta producers and refinery stocks.

That means, upon earnings, sell half of your holdings in EOG, Cimarex and Noble and rotate into E+P's like Devon (DVN) and Hess (HES). 

And as much as I dislike short-term trading anything, I think you'll have a nice quarter or two using refiners like Tesoro (TSO), Phillips 66 (PSX) and Marathon (MPC) as money placeholders. But remember to buy ONLY after earnings reports, which should be bad and will help your entry. 

That's the game plan. 

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