Dec

9

 It is my expectation that we are in the final leg down in crude oil prices for this cycle. I've learned to never predict both PRICE and TIME — so my prediction (based on historical precedents and rig counts) is only that the cyclical spot price low is most likely to be seen in the next 90-180 days. I have no prediction on the exact spot price low but I would neither bet on not dismiss the chance of a seemingly absurd spike low price. Being early can be catastrophic with the contango's roll cost. The June 2016 40/30 put spread costs about $2.5 — so Mr. Market is putting a 25% chance of us seeing 30$/barrel by June. Similarly, Mr. Market is putting a 6% probability of 20$ crude by next June…

If your focus is on the energy stocks (and their weighting in the S&P), you can glean substantial information from watching the behavior of the back contracts out to 12 months– which have NOT made new lows since August. A capitulation in those contracts will start a fresh leg down in IYE, which has so far been telling a different story from the spot crude price. Also, a break down in the long-dated futures will also feed through to the high yield market. Those are the contracts which will can create a lasting jolt to the S&P.

Separately,

I keep asking myself "who are the big winners" from a continued weakness in spot crude?

The "easy" answer has been airlines. (Consumers seem to be saving, not spending, much of their windfall.) But I don't ever own airline stocks.

There is another less heralded winner — which is being validated by Mr. Market.

Local municipalities, agencies and State governments (excluding Alaska, North Dakota, Texas) are huge winners from a continued decline in fuel prices. And this is being confirmed in the credit spreads of these issuers. Also, the bridge and turnpike authorities are seeing increased tolls as car mileage increases. Historically, Muni/Treasury spreads trade as a percentage, so there are some other reasons why these securities might be outperforming.

A bearish third order effect is that car insurance companies are experiencing continued pain due to increased mileage (more accidents), tight premiums, and lower returns on their float.

Lastly, Congress is reviewing the extension of the commercial and residential energy tax credits for installations of solar, wind, and geothermal projects. The current tax credit regime expires next year. The residential tax credit is 30% of the installed cost. Without the credit and at sub-40$/bbl, most of these alternatives do not have reasonable break-even periods. Hence, another "headline" to watch, and which may affect the psychology of the domestic energy market (i.e. longer dated futures) will be whether these tax credits are eliminated.

There have been only a handful of 50%++ energy bear markets in the past 40 years, so the ability to quantify these observations is difficult. That provides an opportunity to devise and implement trades with a variant perspective.


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