Market Call: Short the oil sector

[stockstradr]

I’m willing to post my market calls ahead of the curve. Here is one I did research on this weekend.

It is time to short the oil sector. Prediction: oil is headed below $50/bbl, within 36 months. I have a hunch it will happen sooner, possibly within 12 months.

Personally I’m going with Profunds (Symbol:DUG), a 2X inverse fund that seeks daily investment results that correspond to 2X inverse of the daily performance of the Dow Jones U.S. Oil & Gas index. Essentially you are buying oil futures contracts when you buy DUG.

One of the best articles on why it is time to short oil is in Barrons, Sept 17th, 07, “Where is Oil Headed? A Contrarian Says $45”

Anyway, the story is we have a combination of factors:

1) Global perception that the world is running out of oil has tripled the price of the oil index in the last 4 years. Long-term that perception is correct. However, short-term the numbers don’t support the theory that onset of peak oil is why oil is at $80/bbl. The experts say the numbers (demand and supply) of oil don’t back up the current $80 price. They are saying we are at $80, just on pure speculation.

2) We are now moving into a recession, probably a global recession. Oil demand will fall substantially. The bbl numbers show it already is!

3) Between mid-Jul ’07 and mid-Aug ’07, DJ Oil & Gas Index fell from 640 down below 570, a correction of about 12%. We should have shorted oil back in mid-July. However, we have a second chance. Since then, the index has climbed back up to 630. We are back up at peak overpriced levels.

4) OPEC has raised production again; actually worldwide production has increased substantially.

5) The demand from China and India is overstated. Actually, the experts say that only in 2004 did China’s demand jump by 15%-16%. Since then China demand for oil is only increasing 5% per year or less, from 2005 on.

RISKS: global political instability could obvious spike oil prices. More bad weather that destroys oil producing capability could spike oil prices. The USA attacking Iran would send oil prices off the charts. If China has another year involving 15% increase in oil demand, that could also be a problem, same for India. Finally, I’m betting against the current (oil prices will rise long-term)

[Ash Housewares]

The USA attacking Iran would send oil prices off the charts

I think there’s a very good chance of this happening. Over then next couple months we’ll continue hearing stories about Iranian weapons and training supporting the insurgency in Iraq. This will be used as a justification to launch a small strike on a few Iranian targets. The Iranians will react to this and in doing so will give Bush some sort of justification for launching a much larger campaign in Iran. He does not want to leave office with the Iranians still working on nukes.

[stockstradr]

I think there’s a very good chance of this happening.

Yes, I consider the chance of political instability in a major oil-producing nation (either political revolution, civil war, or war with another nation) is unquestionably the most significant risk for any short-term bear strategy on the oil sectory.

I have decided no more than 10% of my total portfolio will be put into short oil positions. Today I took a 4% of portfolio position in DUG, the 2X inverse fund.

My short-term gamble is that as market participants transition (in the next five months?) from nervous uncertainty to certainty that we are entering a recession, then oil prices will drop at least 10% simply on expectations of lowered demand.

[asragov]

Shorting is risky.

You hopefully are very well aware of what is going on in the oil industry to make such a bet.

Very smart, connected people, even the ex-Chairman of Shell (see link), see significantly higher oil prices ahead.

http://www.hemscott.com/news/latest-news/item.do?newsId=50047106624331

Also see:

http://www.energybulletin.net/34860.html

Will a recession in the US stop the growth of demand for oil in China? The US is only a small market for China’s exports, so, probably not.

The basic “peak oil” theory is that reserves in the Middle East are much lower than what is claimed, and that production of other fields is now peaking, while demand just keeps growing:

http://en.wikipedia.org/wiki/Peak_oil

Good luck with your trading, but be very careful!

[delicious irony]

Didn’t Uncle Al (Greenspan) mention a reduction of 4-5 million bbls/day would cause prices to spike to $120?

If you believe these guys, production is falling and demand is may still be growing:
http://europe.theoildrum.com/node/2973#more

I agree with the above poster about shorting being risky. So many more things can go wrong than just going long.

What about going long assets that directly benefit from lower oil prices?

[an]

stockstradr, good luck to you on DUG. That is if you’re still holding your short position. It must hurt a little getting a 5.7% haircut. DUG seems to broke the all time low of 42ish set in July. It’ll be interesting to see where the market will go from here after the 50 points cut.

[(former)FormerSanDiegan]

D’oh !

You may be right in the long run, but I think a weaker dollar in the near-term means higher oil (with respect to the dollar). I would rather time this trade when the other Central banks start easing rates, which would take some pressure off the dollar. But, I don’t like to short too often (though I am currently short the dollar via UDN).

[Author]

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