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The Morning After: An Energy Shakeout, Then a Move Higher

Thursday, November 8, 2012 9:20

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(Before It's News)

As I mentioned yesterday in Oil and Energy Investor (“Something Big Hits the Oil Markets… Starting Tomorrow”), the primary problems today are exactly the same ones we had before the election.

In fact, aside from the Dems picking up a few seats in the Senate, the composition remains the same – one party controlling the White House and the Senate; the other with a majority in the House.

For all the criticism of Congress kicking the can down the street, that’s just what the nation as a whole did on Tuesday night.

There will be no possibility of expecting a recovery in an environment of uncertainty about rising taxes and meat cleaver program cuts.

I’m calling this the financial precipice these days because I am tired of saying “fiscal cliff.” But it is one of two things that have pushed the energy markets down, along with markets across the board.

The other is another round of disquieting statements out of Europe about a slowdown. The added concerns from the continent today are indicators the pressure is beginning to affect Germany. If the “Prussian engine” slows down, the European credit situation becomes much worse.

Both of these have a far greater impact than who happens to occupy the White House.

But the divide inside the Beltway remains the real political crisis as we approach the end of the year. Most politicos assume there will be another band-aid put on the sore, but it is the continued uncertainty that is weighing on the markets.

This uncertainty will also weigh on the energy sector, particularly on oil prices.

The actual dynamics of the oil sector (the combination of paper barrel/wet barrel differentials, geopolitical pressures, inventory levels, supply concerns, and infrastructure dimensions, among others) are moving indicators up. Meanwhile, the continued angst over emotional readings of headlines and doomsday pundits are pushing them downward.

The election merely compounded that distinction. That, combined with the aftermath of Hurricane Sandy, has leveled off both crude oil and gasoline prices, with the pressure accentuating amidst a post-election sell off and rising European angst

Both crude oil and RBOB (Reformulated Blendstock for Oxygenate Blending, the gasoline contract traded on the NYMEX) are exhibiting backwardation. That means as you move further on the futures curve, longer out months are pricing cheaper. Not by much, and not a particularly unusual event approaching an election. But enough to discourage holding inventory.

Nonetheless, there is an indicator emerging that does tell us what is likely to happen once the next Washington quick fix is approved (probably just before the roof caves in, if the recent embarrassments of Congressional inaction are repeated) and the troika approves the next Greek bailout (should happen in a week).

Most analysts don’t follow this one, but I have been tracking it for some time.

It deals with the use of crack spreads (in this case, trading futures of crude against futures of gasoline and low sulfur heating oil). While the gasoline situation is leveling off, heating oil and its cousin diesel (they are both produced from the same cut at a refinery) have not. These have been indicating a constricting of the market.

And that constriction will kick in whether or not there is another hurricane and regardless of party labels in the White House or halls of Congress.

That means we are about to see another rising price cycle in the energy markets. The current short-term climate is depressing that breakout. However, once the net band-aid is put on the fiscal problem at home and the credit bailouts take shape in Europe, this will hit.

Fast.

This will not be uniform but will take place with greater amounts of volatility occurring over shorter, compressed time periods (what statisticians call kurtosis). That volatility will hit in both directions, with a medium-term ratcheting up.

The strategy now is to position your portfolio to balance energy sectors, exposure to broader sector events – through selected exchange traded funds (ETFs) and equity issues from master limited partnerships (MLPs) – as well as play the upstream (production) side of energy against the range of midstream essentials (gathering, initial processing, feeder and trunk pipelines, terminals, storage). This should be done in crude oil, natural gas and electricity.

And then hold on. This is going to be a rocky ride!

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