In a sector already tilted toward the bulls, these producers look especially promising to market makers, writes Peter F. Way in Block Traders Oil & Gold Monitor.

Our focus on energy and precious metals is fortunate at this point. Both interests are benefiting from unrest in the Middle East and the resulting uncertainty. The dramatic expansion of buys indicated by market-maker actions continues to support the notion that these folk have a far better than average sense of impending events.

So what now? Do the market pros see the higher prices all disappearing when the dust settles?

Futures prices for crude oil, the largest energy source, have gone through the roof in the aftermath of the Libyan conflict. What was seen then as a possible price range for the April contract of $91 to $99 is now being hedged in the $101-to-$134 range. Subsequent expiration months are being hedged to protect against possible highs of $120 to $140-plus, as far out as December 2012.

Still, the settlements curve for these expirations remains only in the $100 to $102 area, indicating a belief that such upper extremes are likely to be only temporary.

Four effects are being seen:

  • The major integrated oil companies—typically regarded as stable, safe havens for capital—are being pushed up in price by risk-avoidance buying
  • The independent exploration and production companies (E&Ps) are seeing speculative buying interest, as more investors are becoming convinced by industry analysts who have been long forecasting a coming scarcity of “peak oil” production limitations. Their proven reserves can be valued higher by those big oil majors unable to satisfy their downstream production demands from internal capabilities
  • Alternative energy-source companies have new price supports for their fuel reserves
  • The highly cyclical oil services and transportation stocks are enjoying a new boom

Next: The Best Explorers and Producers

|pagebreak|

The Best Explorers and Producers
With 15 E&P stocks meeting our investment hurdle of a 5% risk-balanced gain in the next three months, it may be useful to review some of the qualitative dimensions that could determine which ones would be most satisfying to you.

In the graph below, the bar’s height shows the relative size of prospective price gains, where the odds times the size of historic average losses have been deducted from the odds-weighted gains. Those calculations have been drawn only from that stock’s prior experiences when its upside-to-downside forecasts—inferred from market-makers’ self-protective hedging—were at the same proportions as they are now.

chart
Click to Enlarge

In the graph, the stocks with large upside and small downside forecasts are to the left, and the opposite to the right. So a stock like Pioneer Natural Resources (NYSE: PXD), with a big net return potential and a healthy upside-to-downside forecast, logically might tend to dominate a value investor’s interest.

We see that the average price gain in a typical three-month period following forecasts like the current one was 31%. Unfortunately, the suggested credibility attaches to the other side of the coin. For forecasts like we have now, PXD has had typical downside experiences of -25%—scary ones for most investors.

But what keeps an aggressive (and brave) investor going is the odds. For every minus-25% experience, there were four 31% gains. A consistent, disciplined investor would have an easy shot at 18% returns­, several times.

Still, a life of excitement may not be what everyone is after. They might be far more intrigued by Concho Resources (NYSE: CXO) here—especially when, for every 4.5% loss, there could be eight gains averaging 13%, based on over 100 similar forecasts derived from the option bets of market-makers.

Subscribe to Block Trader's Oil & Gold Monitor here…

Related Reading: