Energy Hedges Soar on Bets Stocks Will Follow Oil Lower: Options

Aug 27, 2014 12:49 am ET

Aug. 27 (Bloomberg) -- Investors are buying protection against losses after a 19 percent rally in U.S. energy shares, concerned they’re bound to fall amid depressed demand for oil.

Options on the Energy Select Sector SPDR Fund have tripled in price since May relative to contracts on an exchange-traded fund tracking the Standard & Poor’s 500 Index, according to six- month data compiled by Bloomberg. The gap widened to 3.3 points on Aug. 14, the widest since January.

Drillers, refiners and pipeline operators in the S&P 500 have advanced 19 percent from a low in February, the most of 10 industry groups in the U.S. benchmark gauge. The gains contrast with oil prices, which fell to a seven-month low last week amid disappointing signs of future demand and the lack of major supply disruptions from ongoing violence in the Middle East. The price discrepancy is poised to end, according to Guillaume Duchesne of BGL BNP Paribas SA.

“It’s too early to invest in energy stocks because of expectations of a supply constraint,” Duchesne, an equity strategist at BGL BNP Paribas in Luxembourg, said by telephone. “While there are big issues that may come out of the conflicts in Libya and Iraq, the trends in demand are not that impressive.”

The energy ETF, known by its ticker symbol XLE, has rallied 11 percent this year, compared with a 1.3 percent decline in the United States Oil Fund LP, which tracks crude.

Supply Glut

A glut is shielding prices against tensions in the Middle East and North Africa, the International Energy Agency, an adviser on energy policy to 29 developed nations, said on Aug. 12. Global demand growth sagged to its weakest in two years in the second quarter, the Paris-based agency said.

The conflict in Iraq, the second-biggest producer in the Organization of Petroleum Exporting Countries, has largely spared the south of that nation, home to about three-quarters of its crude production.

The Energy Information Administration, the U.S. Energy Department’s statistical arm, forecast the nation’s output of crude oil will climb to 9.28 million barrels a day next year, the highest level since 1972. The agency cut its 2014 price estimate for West Texas Intermediate to $100.45 a barrel from a July projection of $100.98.

The nine most-owned options on the XLE are bearish, data compiled by Bloomberg show. Puts betting on a drop to $95 a share by October have the biggest ownership, followed by contracts calling for such a decline by Sept. 20, according to the data.

Still Attractive

Energy producers are still attractive, especially when compared with most of the U.S. stock market, where it has become harder for equity investors to find value, according to Russ Koesterich of New York-based BlackRock Inc., the world’s largest money manager. Energy stocks in the S&P 500 trade at 15.2 times projected profits, compared with 16.8 times for the broader gauge, data compiled by Bloomberg show.

Violence in the Middle East may also boost oil prices in the future, as Iraq struggles to ramp up production at the rate energy analysts estimate, creating supply constraints, said Koesterich, the chief investment strategist at BlackRock.

Bearish options trading is “a reflection of the fact that oil prices have come off dramatically in the last four to six weeks,” he said in a phone interview. BlackRock oversees $4.32 trillion. “In the long term, energy stocks still represent good value.”

Earnings Growth

S&P 500 energy companies are poised to see profits increase for the first time in three years. Analysts estimate earnings at oil and gas suppliers will climb 9.9 percent in 2014, data compiled by Bloomberg show. Sales are projected to jump 9.5 percent, the most since 2011, the data show.

The Chicago Board Options Exchange Crude Oil Volatility Index fell 6.1 percent this year to 16.68 yesterday. That’s less than the 15 percent drop in the CBOE Volatility Index, which tracks S&P 500 options prices.

Rallies in energy companies have spurred investors to hedge their gains by using the broader-based energy ETF, according to Chris Jacobson of Susquehanna Financial Group LLLP.

Halliburton Co. has surged 38 percent this year as the world’s largest provider of hydraulic-fracturing services said demand for fracking in North America has turned a corner. The Houston, Texas-based company boosted its operating profit margin in the region and grew revenue by 14 percent.

Williams Cos. has rallied 53 percent in 2014 after promising a 32 percent dividend increase in June. Profit at the fourth-largest U.S. pipeline operator will jump 27 percent this year, according to analyst projections compiled by Bloomberg.

“We’ve seen a pretty consistent trend of protective put buying in the XLE,” Jacobson, an options strategist at Susquehanna in New York, said in an interview. “The group has been one of the better performers on the year, so there may be a general interest in protecting gains.”