Oil Guru Drills into Decline

10/17/2014 10:00 am EST

Focus: ENERGY

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

In light of the sharp decline in oil prices, we turn to energy expert Elliott Gue to find out what's going on in this volatile market. Here, the editor of Energy & Income Advisor offers his outlook and highlights the best energy plays for both traders and long-term investors.

Steven Halpern:  Our guest today is Elliott Gue, editor of Energy & Income Advisor.  How are you doing today, Elliott?

Elliott Gue:  I’m doing well.  Thanks for having me on.

Steven Halpern:  Well, as we speak, the markets appear to be in free fall.  Can you give our listeners any words of wisdom regarding how they should respond to the current environment?

Elliott Gue:  Well, I look at the current pullback as really just that—a pullback or a correction—and we’ve had about 18 months of uninterrupted rallying going on in the S&P and the bottom market, so I think this is really just a normal correction after a big move higher.  

Generally speaking, if you look at the economy, the US economy, things like to be on pretty solid footing.  I think the US economy is going to manage to grow around 3% for the balance of 2014 and into 2015.  

I think, with that backdrop, the corporate earnings are going to be pretty solid and the market really is well supported and I think what we’re seeing is just the sort of shake out and correction that you typically see at this stage of a bull market.  I think, generally speaking, it’s a time to look to be a buyer of select stocks that are well-positioned.  

I would caution, of course, that these things can be very scary and very violent and I don’t know that we’re quite at the bottom yet of this move, but I do think that, generally speaking, the market will be higher by the end of the year.  

Steven Halpern:  Now, you’re well known as the newsletter industry’s top expert on the oil sector, so I have to ask, what’s going on in the oil markets?

Elliott Gue:  The oil markets have been extremely volatile lately and a lot of it has to do, actually, with the supply side of the equation and it has been a little soft, particularly in the emerging markets lately, but I think the bigger problem, really, is on the supply side.  Specifically, we’re seeing somewhat of an argument going on within the OPEC cartel and what we’re seeing is that there’s just too much oil production out there.

We’re seeing Libyan oil production ramp up after having been, sort of, there has been a ceiling on the Libyan oil production as a result of sort of the aftermath of the war there, the civil war there.  We’re seeing production ramp up there, and at the same time, we’re not seeing other countries in OPEC cutting back on their production to, sort of, offset that.  

In addition, of course, over the last five or six years, we’ve seen, pretty much, a continual increase in US oil production—as a result of shale boom—and that’s really totally changed the global market to crude oil, and what I mean by that is that it used to be that the US was the world’s largest importer of crude oil, and a lot of those imports are now being displaced because US domestic production is rising so rapidly.

Just to give you an example; for 20 straight years, the US imported oil from Nigeria and West Africa every single month and, in September of 2014, we imported absolutely no oil from Nigeria.  Just three years ago, we were importing over $1 million barrels of oil per day from Nigeria.  

If you think about that, all that oil—that used to come into the US market—is now looking for a new home and so everybody is sending it to places like Asia, where there is demand to pick up that oil.  The problem is, is that you’re seeing a lot more competition now between all these OPEC countries looking for markets for this excess oil.  

Historically, what’s happened in this type of an environment is the Saudi’s have cut production unilaterally to balance the global oil market.  They’re a little bit reluctant to do that right now.  

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The reason they’re reluctant is every time they do that, the other countries in OPEC don’t really carry their own weight and they continue producing at close to full capacity and, you know, so they make a lot of money by pumping oil at higher prices and the Saudi’s are the only ones who are relied upon to, sort of, balance the global oil market.  

I think what’s interesting right now is the Saudi’s willing to punish the other wayward OPEC members right now, by allowing oil prices to fall.  Longer-term though, I think the Saudi’s actually have to have oil prices above about $93 a barrel—and that’s Brent crude oil prices above $92 a barrel—in order to balance their spending, their budget, their national budget.  

The reason being is they have actually committed to doing a lot of social spending over the last few years in an effort to, sort of, quell any unrest that might move to Saudi Arabia.  

I do think that by early 2015, the Saudi’s will be cutting production, but in the short-term, you could see a little bit more downside in Brent crude oil because the Saudi’s are really looking to punish other OPEC members and also punish some of the shale producers a little bit as well.  They’re allowing their franchises to fall which is hurting their profitability as well.  

Steven Halpern:  Let’s look at two different time prospectors.  From a trader’s viewpoint, looking out over the next few months, could you highlight a few names to offer somebody to consider?

Elliott Gue:  Absolutely.  I think that probably the most reliable angle right now is not so much whether oil prices have bottomed, or have a little bit further downside to go, but I do actually think we’re going to see a spread between US oil prices like West Texas Intermediate Crude and global oil prices, which is typically, the common benchmark is Brent.  

Right now that spread has dropped down to Brent only trading at a two or three dollar a barrel premium to WBI.  Earlier this year it was over $10 a barrel.  I think that that spread has to widen out.  

The reason is, is that at current prices, it’s actually more profitable for US refineries in the Gulf Coast to import Brent crude oil and refine that, instead of using domestic crude oil, and so, as a result, we’re going to begin to see a buildup of domestic crude oil supplies and increased imports of Brent into the US and that’s going to have the effect of raising demand for Brent, pushing prices higher, and to put then increasing supply of domestic grades and pushing prices lower.  

Now, the prime beneficiary of a widening spread is actually the refining industry. These companies make money by buying oil, refining it into gasoline, and diesel fuel, and selling those products.  They benefit the most when the spreads between US crude oil prices and international crude oil price is the highest.  

A couple of names I’d mention, Valero, symbol is (VLO).  Has a lot of refining capacity on the Gulf Coast.  Now places along the Gulf Coast are some of the most advantaged in the US.  

Looking at a little bit more aggressive plan, I would look at Alon USA Partners LP, the symbol there is (ALDW).  

This company is organized a master limited partnership, or MLP.  They have one refinery, which is located in Big Spring, Texas, which is in western Texas.  Now, oil prices in west Texas—in the heart of what’s known as the Permian basin—are much lower than almost anywhere else in the United States.  

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This particular refinery is seeing very fat profit margins as a result of their ability to refine that very cheap oil there, and sell gasoline, and diesel into the global market at much higher prices.  They’re earning very, very fat profit margins right now.  

In the second quarter, they had what’s known as a refinery turnaround, which means that they were doing some maintenance work on one of their refineries, and, as a result, their distribution, their quarterly distribution was rather low.  It dropped all the way to 13 cents a unit.  

I think that now that that refinery turnaround is finished, we’re going to actually see their through put—the amount of oil that they process—rise very rapidly again, and we’re seeing very fat profit margins again from that refinery in west Texas.  

I think their distribution is going to jump back up to as much as a few dollars and 50 cent annualized rate, and at that payout from an annualized basis, they’re probably yielding about 13% or 14%, so ALDW would be a great way to play that.

Steven Halpern:  Okay, so switching to the long-term, perhaps you’d highlight a couple of favorite ideas for somebody who is looking to build energy positions over the next couple of years.

Elliott Gue:  Sure.  I think that what we’re going to see over the next couple of years, and I do think that I mentioned earlier, that I think we’re going to see the Saudi’s ultimately go ahead and cut production and perhaps some of the other OPEC members will be more inclined to play ball this time, because they got burned by basically by the Saudi’s allowing oil prices to fall too much.

So I think they might be a little bit more willing to play ball, and as a result, I do think Brent crude oil prices are going to go back up again and that should help put a floor as well under US crude into the beginning part and first quarter of 2015.  

As a result, I think if you have a little bit longer-term timeframe, I would actually be looking at build positions in some of the oil and gas producers and services companies that have been hit so hard at the end of this year, so it maybe a little early yet to go all in but I would certainly look to be building positions in some of the high quality names in that space.  

Some of the companies that I have recommended are Schlumberger, which is the world’s largest oil kerosene company.  The symbol there is (SLB).  

I would also look at some of the high quality US producers, and by that, I would mention names like EOG Resources, symbol (EOG) and I would also look at a company like Noble Energy, symbol (NBL).  

These companies have very attractive acreage and some of the most prolific plays in the United States.  Some of them, including EOG, can even make money with oil prices much lower than where they are today.  

Right now, they’re, obviously, all of their gains are getting hit pretty hard because of the general sell off in energy space but I would generally look at that weakness, especially gradually building a position into that weakness, as we had into early 2015.  

Steven Halpern: Well, it’s fascinating to get your overview on both the market and the energy sector.  We really appreciate you taking the time to share your thoughts.

Elliott Gue:  Well, thank you for having me on.

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