Two Moves to Make If Government Does the Unthinkable

by | published September 26th, 2013

It used to be the unthinkable that Uncle Sam would be unable to pay his bills.

Yet, thanks to the most dysfunctional political environment I’ve ever seen, the collapse of the full faith and credit of the United States is a possibility we’ve had to get used to.

And in what is now shaping up to be an annual political rite of passage, we’re plodding along again to another budget brawl.

According to the Treasury, if nothing is done to extend the debt ceiling, certain programs will begin to be shut down in as little as two weeks. Once that happens, the market will be faced with the prospect of a default-no matter how slim.

So, what would our approach to the energy sector be if the unthinkable actually happens?

Here’s my game plan for brewing crisis…

Is the Economy About to Get Derailed?

Of course, I still believe there will be an eleventh hour resolution. Not of the underlying fundamental issues mind you. No, it will be just enough to keep the government operating for a few more months.

Just a few years ago a “resolution” like this would have rattled investors even more. But this is the new reality we have come to face and the market has accepted it.

But make no mistake: A government shutdown would paralyze a wide swath of the economy, albeit some more immediately than others.

The good news for energy investor is that energy is a fundamental ingredient in just about everything we do, whether the central government is paying its bills or not. However, the return of recessionary pressures (certainly a result from any prolonged shutdown) will depress market sentiment across the economy.

That tends to reduce expectations for energy use, with oil and gas futures contract pricing taking the upfront hit. Much of this reaction will be hype, since the results from a slump won’t actually occur that quickly. There may be consternation, but the figures justifying any conclusion of downward pricing from genuine supply and demand factors take at least a quarter to develop. And even then they are preliminary.

The decline will come from a rush to short just about everything in sight and an overreaction to what it really means. Anecdotal knee-jerk reactions will just accentuate the move down.

And it is not possible to determine beforehand the real drop in oil and gas pricing, although oil will likely take the heavier hit. That is because we are moving into the winter heating season and a normal winter will tend to buttress gas prices.

Two Ways to Play the Budget Brawl

But that doesn’t mean investors will have to stand idly by. During a protracted budget impasse, there will still be two winning plays.

One involves a segment that almost always improves when the price of hydrocarbons moves south. It is a contrarian play of sorts. The other is the latest reflection of a change we have talked about here in OEI on several occasions.

Remember, both of these strategies merely reflect something that is true even during times of crisis. The demand for energy never goes away. The trick is to locate those areas where the volatility occurring across the markets will actually open up profitability.

This contrarian trend will occur in utilities, especially those that can make use of multiple fuel sourcing (natural gas, coal, solar, wind, geothermal, biofuel, nuclear). Utility profit margins always improve with a decline in the cost of generating electricity. The key is the ability to be able to swap fuel sources to maximize both efficiency and availability.

With the improvement of solar and wind to grid parity (a cost equivalent to traditional fuels), there will be a better mix of sources than in the past. Regional positioning and network access will also be factors. But increasing your weight in selected utility stocks – at the expense of positions in oil/gas holdings and assets – is one way to offset the uncertainty from a budgetary default.

As for the second strategy, it involves the changes taking place in the production of oil and gas itself. Here, we return to a theme I have addressed before. The size and positioning of operating companies will be decisive in identifying profit centers, even in an overall market decline.

Bigger Isn’t Always Better When it Comes to Oil

In this case, think “small oil”…not the big boys.

As we have discussed before, the rising threshold of field profitability for larger companies has opened up a range of new opportunities for well-focused, well-managed, smaller companies to post better profits than the big boys can.

These companies tend to emphasize only regions and basins in which they have considerable (and successful) experience. In the current climate of rising domestic U.S. production, that translates into increasing aggregate production at home with more of that coming from the well-positioned smaller producers.

There will always be demand for oil and gas, even if that demand is projected to decline due to a government shutdown. What will happen here is classic textbook: cheaper to produce oil and gas will replace that which is more expensive. That will allow selected niche operators to make a better profit– even during down times.

Should we ever actually get to the point of a shutdown, I will be going into more detail on how to approach both of these alternatives. At this point, there is still some time before the wheels begin to grind to halt.

By then, the odds are that another arrangement to kick another can down street will emerge.

Of course, I still hope that Congress and the White House will wake up and realize this is not junior high school.

But even if they don’t, we’ll still be able to post a good return in an unsteady market.

PS. Until then, here’s the scoop on an overseas deal that will rocket no matter what happens here the states. After five years, the “gag order” on a $175 trillion oil and gas deal I’ve been working has finally been lifted… now one stock is about to go ballistic. Go here for all of the details.

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  1. October 1st, 2013 at 16:59 | #1


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