OK, oil is crashing. Tuesday, anyway. After some back-and-forth with TheStreet founder Jim Cramer about his "oil is crashing, it's going to $40/barrel call" in early-November, I can't describe Tuesday's 8% plunge as anything but a crash. I don't think we're going to $40 a barrel or anywhere near that, but there is a very interesting confidence driving Tuesday's bloodbath. The last trade for the current front-month West Texas Intermediate crude contract is Wednesday at 2:30 pm. ET. The Federal Reserve's Federal Open Market Committee will conclude its two-day meeting Wednesday and issue a statement at 2 p.m. So as the oil pits are closing Wednesday Fed Chair Jerome Powell will be in the middle of his all-important post-statement press conference.
So Tuesday's action shows that oil traders are rolling from the January contract into the February contract and that roll is heading downhill. Big time. The February contract has traded more than 10x the volume (877,000 vs. 77,000) as the January contract Tuesday, as traders look to settle up January positions. Very few oil futures contracts (I believe the number is much lower than 10%) live to see physical settlement at the Cushing, Okla., hub, so don't be confused.
This move in oil isn't being driven by OPEC or Russia or the guys in the Permian, this is paper chasing other paper in a negative direction. It will turn around as quickly as it started. In fact, the next data point is the U.S. EIA's Weekly Petroleum Status report due Wednesday at 10:30 a.m. ET. Last week's report was quite bullish for crude, showing a 1.2 million barrel decline in inventories and a slight decline in production to 11.6 million barrels per day (MMBPD) from the 11.7 million bpd weekly average that had held for the preceding month.
There was als an inventory report later Tuesday from the American Petroleum Institute, but you should ignore the API data, as most traders do, owing to concerns about methodology. No, the EIA report is the key factor here, and coming on the same day as the Fed it is certainly going to be a key one. The "analyst estimates" I see for EIA data are horribly inaccurate, but I would certainly be happy with another 1.2 million barrel draw in U.S. crude inventories and a stable U.S crude production figure of 11.6 million bpd in Wednesday's EIA report, and I think energy traders would be, as well.
Ideally for oil bulls Powell and his FOMC will present a dovish tone Wednesday. Other things equal that would serve to weaken the U.S dollar (helping dollar-based oil prices) and perhaps stopping this ugly decline in risk-asset pricing in global equity markets.
Remember what I wrote above; Tuesday's oil crash is simply paper chasing other paper. So a drop in the value of U.S. equities can influence balanced funds' appetite for holding commodities, and the interlinkage of global markets should never be ignored.
Generally the ones who display such ignorance are hedge funds. This year has already seen the collapse of several energy-focused hedge funds, notably Brenham Capital, and I am hearing rumors that others are on the brink. So, Tuesday's selling could also be caused by forced liquidation due to margin calls. In fact, I'd be surprised if that weren't happening.
How do you play this? It all depends on your level of belief in Tuesday's move:
If you are on Team Portfolio Guru (disbelieve/Tuesday is a major buying opportunity) on this one, you should be buying leveraged ETNs that are priced based on 2x or 3x the daily move in crude futures. I have been buying United States 3X Oil (USOU) for client accounts this afternoon, an ETN that attempts to replicate 3x the daily move in crude. This is a very, very, very risky tactic, so please be careful, but if you live for contrarianism, that's Tuesday's trade.
If you are moderately bullish, have a longer-term horizon and aren't deathly afraid of the Fed, buy the global integrated players and their strong balance sheets and lock in the yields. BP (BP) (6.5%) Exxon Mobil (XOM) (4.6%) and Royal Dutch Shell (RDS.A) (6.6%) are looking TASTY from a yield perspective Tuesday. Don't delude yourself that those stocks don't have more downside if the Fed disappoints Wednesday, though. Every stock does. But those dividends are quite safe, as those companies have downstream divisions that benefit to a degree from lower crude prices and derivative divisions (plastics, etc.) that unequivocally benefit.
Finally a Portfolio Guru name. Shares of Evolution Petroleum (EPM) have been hammered with the rest of the independent E&Ps for the last two months, but EPM stands out among its peers by carrying ZERO DEBT. There's no solvency risk at EPM, and management is committed to maintaining and opportunistically increasing its $0.10 quarterly dividend, which offers an annualized yield of 6.0%.
So, if you can handle the slings and arrows, Tuesday is actually a good day for the initiation of income-seeking positions in energy stocks.
I end every e-mail I send to the energy companies for whom I consult with "Excelsior," Latin for ever higher, but Tuesday I am really just looking for "Pausa," which translates obviously.