NEW DIRECTIONAL CALL PLAYS
Energy SPDR ETF - XLE - close: 100.39 change: +0.38
Stop Loss: 97.95
Target(s): To Be Determined
Current Option Gain/Loss: Unopened
Time Frame: 8 to 12 weeks
New Positions: Yes, see below
Why We Like It:
Energy stocks are some of the stock market's best performers this year. The S&P 500 index is up +7.4% year to date. The XLE is up +13.4%. Earlier in the year a harsh winter helped drive demand for heating fuels. Now the industry is boosted by rising geopolitical events between Ukraine & Russia and more recently a Sunni jihadist uprising that is pushing Iraq toward a civil war.
Iraq is the third largest oil producer in the Organization of Petroleum Exporting Countries (OPEC). The country produces about three million barrels of oil a day. Iraq also accounted for over half of OPEC's recent production growth. Today the world is concerned that a civil war between hard-line Sunni Muslims in the north and northwest of Iraq and the Shia Muslim government in the south and southeast could damage or severely handicap Iraq's oil production. Meanwhile the Kurds will carve out their own independent nation at the very northern tip of Iraq.
Why should we care about a civil war in Iraq and its three million barrels of oil production a day? We should care because the difference between global oil demand and global oil supply is very tight. The U.S. Energy Information Administration (EIA) estimates that global oil demand will be in the 92 and 93 million barrels a day (mb/d) range in 2014-2015. Furthermore demand will rise 1.2 mb/d both in 2014 and 2015. The Paris-based International Energy Agency (IEA), from the latest data in June 2014, estimates global demand will rise 1.3 mb/d in 2014 to a total of 92.8 mb/d. Yet global supplies are only at 92.6 mb/d.
The world is already falling behind on oil supplies. People often forget that once you drill an oil well production is always declining as there is less and less oil in that well. Eventually wells run dry. Globally this lost production is between -3% and -5% a year. Not only do we need to discover, drill, and produce another +1.3 mb/d to meet growing demand we also have to replace the -3.6 mb/d we're losing every year due to maturing wells. That's almost 5 million barrels of oil a day!
You can see now why Iraq's 3 mb/d production is a focus for the equity markets. We've been lucky so far that nearly all of the fighting in Iraq has been in the northern half while most of the country's oil production and infrastructure is in the southern half. Thus far Iraq's production has not been seriously damaged. There is no guarantee the fighting will stay contained to the north. What happens if Baghdad falls or if the country is permanently divided? Terrorist could target Iraq's production facilities and pipelines.
Fortunately oil production in the U.S. is booming. America just hit 11 million barrels a day. That makes the U.S. the biggest single producer in the world. Current forecast put U.S. production hitting a peak of 13.1 mb/d in 2019. Unfortunately global demand might rise by another 5 or 6 mb/d by then (let's not forget the lost production from declining wells).
Oil prices will most likely remain elevated for an extended period of time. That should mean good news for all the energy companies, up stream, down stream, and everyone in between. A good way to play this strength in energy demand is the XLE, the Energy Select SPDR Exchange Trade Fund (ETF).
The XLE is a basket of over 40 of the biggest names in the energy space from production, to drilling, oil services, and refining. The XLE's top ten components are:
Exxon Mobil (XOM)
Chevron Corp. (CVX)
Schlumberger Ltd. (SLB)
EOG Resources (EOG)
Pioneer Natural Resources (PXD)
Halliburton Co (HAL)
Occidental Petroleum (OXY)
Anadarko Petroleum (APC)
The Williams Companies Inc. (WMB)
As the violence in Iraq worsened last month we saw the XLE sprint higher in the first three weeks of June. When the stock market experienced some widespread profit taking on June 24th traders rushed into to lock in profits on the XLE. Since then the ETF has been slowly drifting higher.
We believe the up trend continues. The July 1st high was $100.66. Tonight we're suggesting a trigger to buy calls at $100.75. We'll start this trade with a stop loss at $97.95.
Trigger @ $100.75
- Suggested Positions -
Buy the Oct $105 call (XLE141018C105) current ask $1.00
Option Format: symbol-year-month-day-call-strike
Entry on July -- at $---.--
Average Daily Volume = 8.8 million
Listed on July 05, 2014