When To Take Profit In O&G Producers, Again?

Hi all,

As usual, I am writing this to (a) bounce around ideas and (b) have something written down to check my own self-selective biases and to evaluate my track record as an investor EOY.

I was long in O&G for 2020 (bought XOM at around $32*), rode the Delta Wave in 2021, saw a possibility of making a few extra percentages during Omicron. So I exited O&G, shorted them, exited the shorts and then re-entered on the long side. As oil equities have risen around 10-30% YTD, I am again faced with the question: “what now?”

• *As WTI rose, the risk curve of investing in oil equities shift leftward. To maintain my risk appetite and return, I started transitioning to more levered bets on oil (so XOM to OXY, PDS, OVV). The downside of this is that these names are more sensitive to WTI movement both ups and downs, within a range.

Valuation-wise, O&G equities are still quite attractive compared to where WTI is. Depending on the stickers and where WTI will be in the next 6 months (as long as it stays btw $65-75/bbl), I think o&g equities have another 10-50% run from here. If bad comes to worse, it's still likely that o&g will yield between 10-30% FCF for 2022, absent a recession.

WTI price-wise, $90/bbl WTI, if adjusted for inflation, is actually only equal to about $72 in 2010. Expenses associated with energy consumption as a percentage of GDP per capita (60k today vs. 48k in 2010) are also not outrageous. Unlike most of the oil bulls, I expect the break-even price will rise with inflation as costs of labor and new equipment rise, at least in the short term. If break-even rises to $65/bbl, that $90 WTI doesn't seem so outrageous anymore.

Supply-demand imbalance, there is a considerable consensus among heads of commodity traders of the big banks (with a vocal minority of opposing views) that we're still in the early innings of an energy supercycle. Also, the IEA recently published their report pushing back their previous timeline of when supply will outstrip demand. FWIW, their views are the market's views.

• I continue to have a middle-of-the-road view btw the two extremes presented by the mega bulls and bears of oil. Conservatively, I think it's safe to say that WTI will continue to stay rangebound btw $65-75/bbl for 2022. However, I expect US shales will become a significant player again and supply will start outstripping demand in 2H2022.
• As such, I have and continue to position my portfolio toward O&G servicers and equipment. Historically, the servicers' profitability lagged the producers by about 18 months. At this point, I am fairly confident that this pattern will repeat this time, absent a recession.

Mass-psychology wise, I continue to think we're in the very early innings of mass euphoria in O&G. There is little to no pumping of O&G in r/wallstreetbets or r/stocks. When there is mentioning, it's usually household names like XOM or CVX. I joke that I will know that we reach peak euphoria when retail starts peddling pre-revenue O&G names. I don't invest based on the assumption that others will become irrational, but it informs my decision of when to take profit.

In conclusion, depending on what happens between now and EOY, I plan to take profit in the O&G producers sometime in 2H2022.

O&G moves fast and things can change in the blink of an eye. As usual, I reserve the option to change my thesis as events unfold (will update if I do).

I receive a lot of counterarguments/pushbacks for my shorts during the Omicron Wave. But I think that made me a better investor. So, call me out.