Friday, April 8, 2016

Is Oil at Rock Bottom?

You've probably heard by now the bullish and bearish cases each with compelling arguments in their own rights.  Regardless of the details on storage capacity and dollar strengthening the simple truth about oil's surprisingly low price is that a new technology called "fracking" has been invented and it has pulled more oil out of the earth than anyone could have imagined.  It is nearly impossible to value oil right now due to the disruption that has been caused by this new technology.

Despite all of the issues with the energy sector right now I tend to find myself in the bullish camp based on the simple fact that it has been priced for destruction meaning the risk reward ratio is undoubtedly skewed towards reward.  Here are a few other factors that I am leaning on to help me with this decision:

1. Many world economies are dependent on the energy sector for their GDP meaning that there will be powerful forces working towards a favorable outcome...the energy sector is literally "too big to fail" times a hundred.

2.  People need four things to survive - air, food, water and energy.  Right now the cheapest form of energy available is oil and due to obvious circumstances I do not see a lower priced contender stepping up anytime soon...which tells me that the energy sector will survive and eventually recover at some point in the future.

3.  Value premium is especially ripe in energy at the moment as the perception of risks are through the roof.  Looking at a fifty year time span of oil pricing shows that the commodity has not been priced so favorably in over a decade.  In fact, based on more recent history, it would be a very normal thing if oil were to rise back to $140 over the next several years.

All this being said, it isn't clear which energy companies will survive so I am sticking to energy sector funds in order to avoid specific company bankruptcy risks.  I am also attempting to extract income from selling volatility premium on oil itself.  Whatever you decide regarding the energy sector...don't over do it, stay diversified and think long term.

Read Next: Is Now the Time for an Oil Volatility Linked ETF?