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Energy Sector Approaching Negative Seasonality at Trader’s Narrative





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Last summer, on June 2007, to be precise, I wrote that the caution was warranted for energy sector. Let’s take a look to see how I did and what lies ahead for this area of the market.

The energy sector managed to push a little bit higher in July 2007 but it then succumbed to the general market weakness. So since I wrote about my apprehension it didn’t go anywhere really for the next two months:

phili oil services index OSX

The strength of this sector was undeniable in 2007. In fact, last year it bucked negative seasonality to deliver one of the best sector returns. Usually, from the beginning of June to the beginning of December energy stumbles. In fact, in the past decade only 3 years have bucked this negative seasonality. On the other hand, once December rolls around, things do tend to rock and roll.

Seasonality
The logic behind the seasonal influence is the seasonal weakness in the commodities themselves. Natural gas and oil are weakest in the summer (May to July) and strongest in winter. So right now we are just about to enter the worst time of the year to be long oil and gas stocks.

On top of that 82% of stocks in the Energy Select SPDR (XLE) are trading above their 100 day moving average. That’s not the maximum but it is high. As well, the bullish percent for the sector is a bit “toppy”, hovering below 80%:

bullish percent energy sector May 2008

The smart thing to do was buy in January and March 2008 when the bullish percent spiked down to 20% (and less). But you already knew that because you know how to time the market using bullish percent charts, don’t you? ;-)

On Wall Street it depends who you listen to. Goldman Sachs is hyper-bullish on oil awaiting $150-200 a barrel oil while Lehman Bros. thinks that prices will fall to $83 a barrel in 2009 and $70 by 2010.

What about Peak Oil?
I don’t buy into “Peak Oil”. We will either discover more oil, better extraction methods for existing reserves or move to alternative energy sources. Take new discoveries for example: Thanks to the Tupi discovery, Brazil will become a major oil player - probably joining OPEC as a result. But that is years in the future, assuming all goes according to plan. Petrobras will have to drill more than 16,000 feet under the seabed, itself under 10,000 feet of water. The reward though is tantalizing: 5-8 billion barrels of oil and natural gas.

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8 Responses to “Energy Sector Approaching Negative Seasonality”  

  1. 1 Keith Shepard

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    >>I don’t buy into “Peak Oil”.

    Yep. I don’t buy it either. I think it’s bullshit.

    I’m sure we’ll “peak” eventually or even run out at some point, but it isn’t now or near. The fear that’s in the oil & energy markets and perpetuated via the mainstream media and amplified by every tinfoil hat wearing nut-job that is holding oil related stocks, is totally discounting any faith in human ingenuity.

    It’s not like we’re all going to give up and die. How stupid is that? The current peak oil fear has an agenda.

    If we get off our butts and get solar (for example) down to a competitive per-watt price, we can cut natural gas usage dramatically. If we can freak-out about running out of oil, we sure as well can expend the same amount of brain power to optimizing our solar cells and cutting prices down to where even the poor can afford them.

    Oil need a competitor. Maybe “big oil” and the car companies will impede the process long enough for them to figure out how to profit from alternative energies, but I doubt we’ll run out of oil before then.

    We need a cleaner fuel. Expensive fuel might finally push us into living responsibly instead of like parasites. Expensive gasoline, oil and natural gas might finally push the US into diversifying it’s energy reliance.

    We built a society based on dead dinosaurs. How stupid is that?

    ~Keith Shepard

  2. 2 Finbob

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    Is oil running up because of the possible attack on Iran? Iran Premium.

  3. 3 Hardhead

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    The only thing that really has me spooked is the situation in Georgia. Iran is 75% priced into oil already. There will be NO oil shortage in the next 100 years - Analyst and PANIC will be around forever!

    HH

  4. 4 JH

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    Peak Oil doesn’t say that there won’t be any oil left, just that production will reach a maximum for which it won’t return again.

    It happens on all levels . . . individual wells, countries, the world. In 1956, M King Hubbert, using a standard production graph (now called the Hubbert Peak) predicted US production peak would occur in 1970. He was ridiculed then, but he was very accurate.

    There will be plenty of large finds in the world along the way. Peak Oil doesn’t prohibit it. However, it’s likely that the overall world production has peaked, and, at the very least, won’t grow again.

    You track sentiment (and do a nice job at it too!). Think about a bull market where it’s been doubted all along the way. No policies have been created to really address it. People deny it. There are constant predictions of its demise.

    What an opportunity!

  5. 5 Tyro

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    What don’t you get about Peak Oil? Yes, of course we’ll discover more but the discoveries are smaller and smaller. Yes of course we’ll have better extraction methods, but extraction becomes more and more expensive and time-consuming, reducing the rate at which we can extract the oil. Yes of course we’ll find alternatives to oil which will help take its place in our lives (though to what extent is uncertain), but oil will still peak.

    Peak Oil isn’t about running out, it’s about the rate at which oil can be extracted and the cost. When the rate declines, we have peaked. Better extraction methods and alternative energies won’t change that. What’s not to get? What about that is wrong?

    Petrobras will have to drill more than 16,000 feet under the seabed, itself under 10,000 feet of water. The reward though is tantalizing: 5-8 billion barrels of oil and natural gas.

    Fine. They’ve found a very expensive-to-extract oil reserve. Let’s say it were sitting right at the surface and we could extract it for free though we both know this is nothing like the truth. Since OPEC estimates worldwide consumption at 71.7 million barrels per day, an 8 billion bbl discovery would only fuel us for a third of a year. Whoopdy-flipping-do. A great BandAid, but it’s not changing anything.

    This is exactly what Peak Oil tells us - oil will become more and more expensive to extract, and there will be less-and-less available. With discoveries, we may coast for a period, but each discovery is smaller and smaller.

    The US has peaked, do you dispute that? What new factors in the rest of the world exist that could stop what has already happened in the States?

  6. 6 Babak

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    Tyro,
    there is no supply issue. And peak oil has been predicted in the 1950’s, the 60’s, the 70’s, 80’s, 90’s and now it is 2008. Each decade peak oil gets pushed back to irrelevance. Of course each time the price of oil goes up, the peak oilers come out of the woodwork. And each time it goes down they melt into the background without a peep.

  7. 7 Tyro

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    Babak,

    Did you read the article? It doesn’t support the thesis that Peak Oil is a myth. The data it does have all supports the Peak Oil model.

    It says that there is speculation in oil prices which is driving up prices. Sure. It says that oil inventories are rising which is reasonable to expect given the article also says that oil consumption dropped 6%. More tantalizing is where it talks about just what sort of inventories are rising: “Further, Saudi Arabia has extended discounts on its sour crudes to $7.45 for Arabian Heavy. Doesn’t sound like there’s any real supply problem with that grade of crude, does it? ” This grade of oil contains a lot of sulfur and is is relatively expensive to process, which is why people prefer to buy the sweet, light oil but this is already in short supply. We’ve already hit a point where oil that used to be too expensive to process like this sour heavy oil or worse, the Tar Sands in Canada have become economically viable, indeed a necessity. Countries like China have been forced to invest large amounts of money into refineries to handle the heavy, sour crude which is still available.

    This doesn’t mean that we won’t peak, oh no. It’s an illustration of how we’re approaching the peak. Oil becomes more and more expensive to extract and more expensive to refine, and we turn to more and more fringe sources which yield smaller and smaller amounts at ever increasing costs.

    In 2005, The International Herald Tribune writes: “Sour crude sells at a discount to low-sulfur, or sweet crude, because it is heavier and yields less light fuel such as gasoline.

    Oil fields that are producing sweet crude, such as those in Texas and the North Sea, are peaking or have peaked, the International Monetary Fund said in April. Replacement fields are generally smaller, harder to access and produce heavier crude, it said.”

    And peak oil has been predicted in the 1950’s, the 60’s, the 70’s, 80’s, 90’s and now it is 2008.

    That sounds like a misleading even inaccurate portrayal. Hubbert predicted in the 1950’s that oil production in the US would peak in the 70’s and he was right. No one predicted world-wide peak oil would happen in the 80s or 90s, but they did talk about it then. Yes, it’s 2008 and yes they’re still saying Peak Oil is inevitable. What did you expect? It’s even more urgent that we deal with the situation, so of course people will still talk about it in 2008! The difference between 1980 and 2008 is that some people are now asking whether we’ve already peaked or whether we still have a few more years.

    World peak oil is much more difficult to evaluate given the incentives that OPEC provides for gross overestimates of reserves. We can only evaluate how much oil is actually being extracted and refined. How do you evaluate whether oil has peaked, if you’re so confident it hasn’t? How do you take into account the different grades? I’m not saying it’s impossible, only that it isn’t a simple issue as measuring a single number. Certainly an OpEd in BusinessWeek isn’t good enough.

    I’m not saying oil has peaked, but that it is coming, and coming fast with a majority of scientific estimates within a decade and the optimistic ones only to 2020-30 if it hasn’t peaked already.

    I notice you didn’t answer my question: we’ve seen that the US oil has peaked long ago, so what is so different about the geology of the US than from the planet, which allows the planet to continue producing oil at a steady/increasing rate?

  8. 8 countryboy

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    Nice discussion guys. But I have to say that I am in agreement with Tyro. To say that there is no supply issue when it comes to oil is to ignore the obvious - no more oil is being ‘made’ anymore. There is a finite amount of oil on the planet and not even technology, man’s genius or prayers to God are going to change that.

    So clearly there IS a supply issue overall. But given the fact that we can’t know how much oil these is on Earth, the real point is how much oil can we extract at a price that the world can afford?

    Brazil’s new oil fields are going to cost more to develop than any other oil field in the histroy of mankind. And even then, as pointed out, they are not going to make a major difference to total oil reserves. And to be economical we’ll probably be looking at oil p/barrel of $500 plus. Can the global economy, which is based on the consumption of hydrocarbons, tolerate a price like that without breaking down?

    Anyway, global oil production is very close to its peak, if it hasn’t reached it already. The big question is what we can do with demand - if we don’t find a substitute for oil then expect prices to keep increasing.

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