The WTI-Brent spread is in the headlines the past few days as the West Texas Intermediate benchmark is trading higher than its Scottish counterpart for the first time in 11 months. If this trend continues, it is incontrovertibly bullish for U.S. oil producers. It's about time for some good news for the E&Ps, whose stocks have been beaten and bloodied this year and some of whom have had to file for bankruptcy.
First and foremost, I have to offer one caveat. The Brent-WTI spread has narrowed considerably at year-end in four of the last five years and this much-commented-on move may just be a seasonal head fake.
I think it's more than normal seasonality, though. I believe it's the market pricing in the end of the dreaded, outdated, illogical U.S. crude export ban. Republicans in Congress have wanted to kill this hopelessly archaic protectionist piece of legislation for years, and in exchange for renewing subsidies on economically-inefficient industries like wind and solar, they finally found a combination that could be signed into law.
So, just as the market began pricing in the end of the sanctions on Iran's oil industry before they have taken hold (that has not yet occurred as necessary inspections have yet to be completed) the market is pricing in the free movement of U.S. crude after 40 years of governmental restraints.
That brings up the most important factor in trading oil, and why you shouldn't try to do it yourself. The prices we see quoted on CNBC and basically every other news outlet on the planet are futures prices. The most frequently quoted price is the front-month contract for delivery at the end of next month.
So, if you are trying to invest based on one data point -- the front month contract quote -- you are missing the forest for the trees, i.e. the entire futures curve. And if you try to take into account the intermediate-term nature of the oil market by buying a futures-based ETF like the very liquid United States Oil (USO), you will be hurt by the contango.
Because oil is a physical commodity that needs to be stored, the futures prices for upcoming months must take into account that storage cost. Thus a fund like USO has to continuously keep rolling monthly contracts into higher-priced next-monthly contracts. It's the ETF equivalent of averaging up, what traders call "getting killed by the contango," and it's value-destructive.
So, if you want to own oil, you really should own companies that control a physical stock of the commodity itself. That ownership can come through leasehold (most oil companies own rights to drill and develop parcels for a certain time period, not the parcels themselves) or by holding the oil itself.
So, larger E&Ps such as Diamondback Energy (FANG) have figured out how to monetize mineral rights through separate entities like FANG's Viper Energy Partners (VNOM), but smaller E&Ps are beholden to the leaseholders themselves. Some analysts have pointed to lease expirations as a potential negative for the E&Ps in 2016. Theoretically that's true, but in reality the vast majority of oil drilling in the U.S. takes place in areas that are remote, unfertile and unlikely to be used for luxury condo development. Therefore, most landowners choose to renew oil drilling leases when they are near expiration and that will be a common theme in 2016.
But oil still has to be moved, and with the end of the crude export ban (which didn't apply to Canada and Mexico anyway) that U.S.-produced oil can now be moved by sea.
I have pushed the stocks of seaborne crude tanker operators for most of 2015, and I believe they are attractive going into next year, as well. About 70% of a crude tanker's voyage cost is fuel, so low oil prices actually help the operators from an operating standpoint. From a demand standpoint, obviously lower crude prices can spur oil-importing countries to build stockpiles (this is happening now in China), which is supportive for crude tanker voyage rates.
My favorite tanker play remains Nordic American Tankers (NAT), and others in the group are Teekay Tankers (TNK), DHT Holdings (DHT), Tsakos Energy Navigation (TNP), Euronav (EURN) and Navios Maritime Acquisition (NNA).