My landlord is working in the North Sea. He texted me to say he won’t be back until April.
Not that you care about any of that. I mean, I don’t care about any of that, other than the relationship of those facts to when I meet with him to pay my rent here in Prague. But it does mean something to you and me both, which I will come to in just a moment.
Let me first back up momentarily to circa-1991, early in my career as an investor. I read a book titled One Up on Wall Street by Peter Lynch, the legendary portfolio manager for Fidelity’s Magellan mutual fund (it remains my favorite book on investing). One of my takeaways was this bit of wisdom: Pay attention to what’s going on around you because that is your personal early-trade indicator.
Now, back to our regularly scheduled column and that text from the North Sea…
My landlord—coincidentally, also named Peter—works in the oil industry as some kind of freelance inspector of some kind of piping gadgetry that does this or that to ensure something or other on deep sea oil rigs. Clearly, I haven’t a clue what he does. But, frankly, all I really care about is that twice this year so far, Peter has ventured into the North Sea to do whatever it is he does.
It’s the first time he has worked since early summer last year.
He is, therefore, my early-trade indicator. Which means he is, by extension, your early-trade indicator.
That trade: the reflation of oil prices and energy stocks.
Truth be told, that has been happening for the last several months. I tried to get involved with it back in November, but I was too cute by half. I used a particular—safe—options strategy I regularly rely on to buy stocks I like at cheaper prices (I’ll explain that strategy in an upcoming column). I wanted to own Exxon and what was at that time a 10% dividend yield. So, I set up a simple trade with “put options” to grab Exxon at $37.50 when the shares were just above $40. They’d been bouncing around in the mid- to low-$30s for a couple months prior to that, so I figured I’d outsmart the Street, get paid to wait, and then snap up Exxon at a dirt-cheap price.
Alas, Exxon slipped no lower than $38.13 and now trades near $61 as I write this. I missed out on a 60% gain by a measly 63 cents. Win some, lose some.
But here’s the point: That trade was the right trade to make, despite my bad entry price selection.
I saw this move in Exxon on the horizon. It was easy to see. In a world that worships Tesla and the promise of abundant, low-cost green energy, the reality is that fossil fuels aren’t going away anytime soon. The reality I saw was that the world economy was going to rebound from the COVID crisis, and it was going to demand oil for travel and for all the things we buy. (Seriously, Google “products made from petroleum.” You’ll be amazed by how much of your daily life relies on oil byproducts.)
Yet, I also saw this fact: During the pandemic, the energy industry stopped spending billions of dollars on exploration and development—basically, that’s finding new oil reserves to replace the reserves that are petering out.
If you connect a few dots, you realize without much effort that:
- Increasing demand for oil is going to run headlong into a depleted supply, and…
- Oil and gas companies don’t have enough new supply coming online because…
- They spent the better part of a year not spending any money looking for that new supply or developing existing fields.
What I’m saying is that we face a supply crunch at some point. I don’t say that to imply oil prices will moon to $250 or some crazy level. They won’t. But I will not be surprised when oil, now at $60 a barrel, moves past $100 this year.
Peter going back to work in the North Sea tells me the industry is again ramping up. It’s bringing in inspectors to examine all the critical components of mothballed drilling rigs. Although Exxon has moved up sharply from my miss-targeted buy, it still has plenty of room to run. Exxon will likely see the $90s before 2021 is out.
But I’m looking elsewhere at the moment. I think drilling-rig companies will see a marked push higher as 2021 unfolds. Last month, Transocean International announced its latest results: Its backlog of business was lower by about $400 million. The Street freaked out and sent Transocean shares 10% lower, worried that companies such as Exxon, Chevron, BP, and others are still conserving their exploration dollars. That’s true; they are.
Yet, the higher oil prices climb, the more active the energy industry’s greed glands. I’d bet that once oil tops $75 a barrel, we see companies crack open their wallets and start locking in long-term rental contracts for drilling rigs. Rig operators, in turn, will begin charging higher day-rates (the daily rental rates) when leasing their rigs.
And suddenly, Wall Street’s attention will shift to deeply discounted drilling-rig stocks that will then pop higher from their currently depressed prices.
So, if you want to get ahead of the energy reflation trade, start looking there—in the drilling-rig industry. Just don’t try to be cute like I was with Exxon and miss the trade.
